The question that manufacturers and retailers rarely want to voice out loud is "When Can I Raise My Prices?" Input costs have been rising in many categories and across commodities, such as milk and cotton, though some of the measurements in the Commodity Price Indices have come off a March 2011 peak (see our Figure below from the IMF).
Volatility and uncertainty of input costs also drives the need to evaluate customer pricing. This is generally true across the categories of fuel/energy (and feedstocks), metals, agriculture, and consumer staples such as cotton and sugar. But the current economy still leaves most manufacturers wondering if their customers (and, in turn, end consumers) will accept a price increase. Further complicating this dilemma is the move across many consumer categories to more value-oriented brands. Although it will vary somewhat by specific category, value brands typically carry lower margins and are more sensitive to input cost increases.
Surviving Without Price Increases (Until Now)
Quite a few manufacturers and retailers have successfully resorted to various techniques over the last few years, some focused on cost cutting to maintain profit levels, others focused on revenue, including:
- Efficiency improvements such as better energy or transportation management or less packaging material to reduce total costs
- Volume increases to make up for lower profits per item sold
- Less expensive inputs, such as substituting fabrics or minimizing details in apparel or even lower grade feedstocks for chemicals
- More value-focused functionality (and sales and marketing campaigns that emphasize value) or the development of niche markets with less price sensitivity
- Adding features to combat declining prices in that category (such as in some consumer electronics)
- Reduced product sizes without a price reduction ("hidden" price increases)
- Adding complementary service components
- Asking suppliers to lower their prices
There is little question that manufacturers have been able to successfully combat input cost increases with broad cost-savings efforts; however, that is not a bottomless well. As manufacturers have largely taken the "low hanging fruit," they are increasingly finding shortfalls versus rising input costs. Of course, we're also expecting manufacturers to take into consideration economics, the laws of supply and demand, and price elasticity. But we still come down to the fact that there is a good likelihood that manufacturers will have to raise prices in the near-term. And we mean "real" price increases, not those that are given back though enhanced promotional programs.
Raising Prices Should Be a Skill, Not a Guess
At IDC Manufacturing Insights, we believe leading manufacturers are more successful at knowing when to raise price and how to justify that price increase to minimize revenue losses. We're considering basic economics, where a price increase could mean a smaller potential market of customers that will buy the product and not seek alternatives, though we know that price inelasticity is not the same for every category of consumer or business good (or, indeed, for manufacturers selling leading versus lagging brands into a particular category).
The ability to raise prices is a fact-based skill, and one that we think manufacturers and retailers desperately need this year. At minimum, this means continually improving how well they manage product lifecycle costs (from a total landed cost perspective), as well as knowing the repercussions of modifications to materials and design in the product lifecycle and to demand. Of course, for retailers, this is mostly about product development for their own private brands.
From a more general sense, this also means that manufacturers and retailers need to know the hot buttons, the mega trends, what exactly motivates buyers to open their wallets, and maybe that's for health and wellness reasons, sustainability, fashion, performance, or convenience, for example. Yes, manufacturers are going to survey consumers, but they also need to work closely with retailers (B2C) and other manufacturer customers (B2B) to understand what is selling, when, and why.
In a conversation with my IDC Retail Insights colleague Greg Girard, he talked about how some commodity prices have risen dramatically over the last year, and retailers need to watch how consumers respond to these volatile conditions. But Girard is especially aware of the fact that retailers' make or break seasons, back to school and the holidays are just around the corner. With the economy still creeping out of the recession, consumers remain sensitive to price changes. Navigating these dynamics will make the difference between ending the year in the red or in the black. To succeed in the dynamic environment leading up to the holiday season, retailers need to focus on simultaneously better understanding and delivering value to their customers while collaborating with their trading partners by providing visibility into trade promotion performance, pricing, inventory assortment, and shopper behavior.
More Visibility in Pricing Information
We'd like to think that manufacturers and retailers know their costs, though this area still needs work in most companies. But there's also a price visibility element here, too. (Note that I'm distinguishing between price and cost). Buyers and sellers want and are getting access to more pricing information for better comparison shopping for B2B and B2C. It's easier to see from a B2C perspective, where consumers are using mobile devices to check competitive prices and creating what Girard calls the "scan and scram", in other words a consumer checks a price of the same or a competitive good on his or her mobile device and decides to go elsewhere physically or virtually for the purchase. Easier access to pricing information is also increasing the universe of items for which buyers know prices, known value items. For example, if you're a frequent buyer of a cup of coffee at Dunkin' Donuts and you take notice of the price every morning, then that is one of your known value items. You know what price to expect.
Of course, there are an increasing number of tools that are being developed to collect pricing information on a large scale, such as MIT's Billion Prices Project using a software tool that essentially scrapes the price of millions of goods off online retail sites to track pricing and pricing changes for a wide range of categories. For manufacturers working from a B2C perspective, it's not just about knowing sell through counts in retail outlets, but also about getting retail price and category revenue details--closely held secrets many retailers are still reluctant to share even with their most trusted and strategic vendors. Of course, if you are a manufacturing selling through Wal-Mart you've been on the other side of the table and forced to open the kimono on your cost structure.
For manufacturers with more of a B2B perspective, much of the knowledge requirements are the same perhaps on a smaller scale but definitely with a greater emphasis on understanding end use applications of the products they are selling and providing a level of customer service that understand their customers' customer requirements.
Putting the Emphasis on Negotiation
In the end, what we come down to is using better information, visibility, and intelligence to negotiate price increases. And I'm associating the negotiation process with some level of consensus from both the buyer and seller, whether we're talking about manufacturers working with their own suppliers, manufacturers selling to other manufacturers, or manufacturers and retailers negotiating with each other and their consumers. It's the volume, integrity, and currency of data behind that visibility and intelligence and the many steps in between the data collection process and the negotiation conversation that make this such an interesting challenge where IT can help.
Thanks to Leslie Hand, Simon Ellis, and Greg Girard for contributing to this blog post, and we'll be producing more research on this topic this year. We'd like to hear how you're working to negotiate price increases. Email me at firstname.lastname@example.org or leave us a comment at our manufacturing blog on theIDC Insights Community site.