This is the second post in a four-part series by Zilliant Senior Vice President of Products and Science Pete Eppele on how best respond to cost volatility vis-a-vis price. Read the first post for a primer on the topic.
Before setting your go-forward strategy to mitigate cost changes with pricing, it’s essential to analyze and understand what history can teach about how customers and product lines have responded to price and cost changes in the past. Meaning, when costs have increased in the past, have prices increased, decreased or remained fixed? What about when costs decreased?
For example, in figure 1.1, a diagnostic of price-cost changes revealed that as costs decreased, prices also declined in response. In this case, the company passed along the savings to its customers. In figure 1.2, the same diagnostic performance revealed that as prices decreased, prices remained fixed. For this time period, the company held onto the cost savings.
In figure 1.3, it was discovered that as costs decreased, prices increased. Finally, in figure 1.4 prices were declining while costs increased. This is clearly the least optimal scenario as the company was experiencing margin erosion as costs increased, likely not at all what was intended with the price strategy.
So, which of the remaining three figures is ideal? At first glance, it could make sense to look at figure 1.3 as the optimal cost pass-through strategy. After all, the company is gaining margin as costs decrease, but how would customers respond to increased prices in a low-cost market? A few micro-segments might not be sensitive to these increases, but some might be highly sensitive and respond in kind by taking their business to a competitor.
In figure 1.1, margins are remaining steady, with price declines following declines in cost. Would this approach have the desired effect of holding volume steady? Perhaps, but an unintended consequence of this strategy is that a significant amount of money is likely being left on the table with customers that aren’t as sensitive to price, meaning it wasn’t necessary to pass along those cost savings.
Finding the best strategy can vary greatly from company to company depending on how volatile costs are, whether or not the company is selling commodity-based products rather than non-commodities, vertical industry dynamics, and customer price sensitivity. In reality, the smartest strategy for responding to changing cost conditions will be quite diverse within one company, with discrete micro segments each having their own optimal strategy.
Stay tuned to Thursday's post when Pete discusses how to determine when, where and by how much to pass cost changes to customers.