Managing cost increases
Seven Tips for Managing Price Increases
June 16, 2008
Consumers get hit with the price-increase hammer every time they drive past a gas station. Harvard Business School professor John Quelch offers tips on how marketers can cope with inflation and consumer sticker shock. Key concepts include:
Segment consumers around product usage behavior and price sensitivity.
Marketers must reverse engineer products and packaging to hit key retail price points.
Cut prices not across the board but only on items selected as your inflation-busters.
Unbundle your offerings to make it easy for price-sensitive customers to cherry-pick options and services.
Manage your inventory on a last-in, first-out basis.
John A. Quelch is the Lincoln Filene Professor of Business Administration at Harvard Business School.
Editor's Note: Harvard Business School professor John Quelch writes a blog on marketing issues, called Marketing Know: How, for Harvard Business Online. It is reprinted on HBS Working Knowledge.
When driving these days, do you look at the prices every time you pass a gas station? Do you notice yourself paying more attention to the prices of everything you buy? You are not alone. Consumers everywhere are more price aware. People who've been indifferent to price increases for years are suddenly amazed at what things now cost. How can marketers cope not just with inflation but with consumer sticker shock?
1. Understand Your Customers. There are at least four ways in which customers can respond to higher gas prices: downgrade from premium to regular; take fewer trips by car, consolidate errands, switch to public transportation; take the same number of trips but reduce the miles driven per trip by, for example, vacationing closer to home; drive more economically and less aggressively to improve miles per gallon; and buy a specific dollar amount of gas rather than filling up every time, even though this may mean more visits to the pump. Some consumers may even trade in (at a loss) the SUV for a hybrid, an example of how price inflation on one product can cause demand shifts in a second, related, category.
More customers than usual will be looking out for price promotions, but don't give away the store to those who don't need the discount.
2. Invest in Market Research. You must discard your existing customer segmentation assumptions and segment consumers around product usage behavior and price sensitivity. You must get out into the marketplace yourself and talk to consumers directly to understand their pain points and how they are changing attitudes and behaviors in response to price inflation. You must then quantify these shifts and develop product and pricing strategies that balance the need to maintain both profitability and market share.
3. Redefine Value. Customers buying soft drinks can think about price in three ways: the absolute cost per can or bottle, the cost per ounce, and, less common in this category, the monthly consumption cost. Customers short on cash will focus much more on the absolute price. They'll go for the 99 cent soft drink rather than the $1.29 container with 50 percent more volume. To motivate cash-poor consumers, marketers must reverse engineer products and packaging to hit key retail price points. This may mean downsizing package sizes, something the candy industry always does in response to inflation.
4. Use Promotions. If you've always passed through raw material price increases to the end consumer, you don't necessarily need to change that policy. However, lagging competitors in passing on price increases can have the same effect as a temporary price promotion. More customers than usual will be looking out for price promotions, but don't give away the store to those who don't need the discount, and cut prices not across the board but only on items selected as your inflation-busters. For cash poor consumers, these promotions should hit the key price points on small pack sizes. For cash rich consumers, encourage multi-unit purchases ahead of the inevitable next price increase.
Strong brands can hold consumer loyalty while increasing retail price points.
5. Unbundle. Customers who previously welcomed the convenience of buying product, options, and services rolled into one may now ask for a detailed price breakdown. Make it easy for your more price-sensitive customers to better cherry-pick the options and services that they truly need by giving them an unbundled menu of options.
6. Monitor Trade Terms. Beware of powerful distributors paying you more slowly than they turn the inventory they buy from you. In an inflationary environment, they're making money on the float by stretching their payables. Manage your inventory on a last-in, first-out basis to insure that increases in your realized selling prices do not trail the increases in your input costs.
7. Increase Relevance. You need to persuade customers to cut back their expenditures on other products, not on yours. In tough times, consumers more than ever need and deserve the occasional treat. So, if you are Haagen Dazs, tell the consumer to substitute private label peas for the name brand but to not forego the comfort of curling up on the sofa with a tub of her favorite ice cream. Strong brands can hold consumer loyalty while increasing retail price points. Weaker brands risk private label and generic substitution.
Clearly, not all marketers are equally affected by price inflation. Commodities like gasoline, where the manufacturer adds little value before the product reaches the end consumer, are more vulnerable, while sales of the most exclusive global luxury brands hold up pretty well regardless of price. Especially challenged are marketers of goods and services for which consumers don't necessarily understand the input costs: decorative candles, for example, are highly sensitive to oil prices and the purchases are discretionary. The key here is to educate the consumer, apologize for the uncontrollable price increases, give price-sensitive consumers some promotional options, and reemphasize product benefits.
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About the author
John Quelch is Senior Associate Dean and Lincoln Filene Professor of Business Administration at Harvard Business School.