Episode #0098 - Why Value-Based Pricing is even more important when inflation is rampant?

Pricing College Podcast

In today's episode, we are going to discuss the importance of value-based pricing during inflation.

In today's episode, we are, I suppose, going to address the big elephant in the room, which is massive cost increases and massive inflation. On a scale, I think people thought we would never see it again. I read this morning that inflation is at a 30 year high. In some countries, it is somewhere between 6% and 12%. That was even before this entire Ukrainian War and petrol prices, fuel prices, and all that sort of stuff. So it is a massive cost increase. In today's episode, we want to say with cost increases why to a large extent, value-based pricing is more important than ever. If you are a cost-plus business, it may seem sensible at this point in time. But really, you are going to face even more problems than usual.

I think that's sort of right. I mean, in times of inflation, you need to understand the value of your product portfolio and the value of your business. How do customers perceive that value? How interested are they? Do they understand the value that they're offering? What's the level of education that's required to understand that value? Essentially, yes, value-based pricing is important. But what most companies do when there's mass inflation is gravitate to cost. Because they see commodity prices increasing, and they are naturally drawn to that. Because they believe if they capture accurately their cost situation, they'll be able to save margin erosion. But unfortunately, tracking costs isn't the solution. And again, you've got to do the hard work there in understanding value and going through that journey. It's a journey, and it's not going to be a quick fix. I think in a way, the problem is that when companies are leaking margin quite significantly during times of inflation, It's almost easier to do what they know. Capture costs rather than go through that journey to understand the value. But often, I think the problem is that once they start to understand or go down that path of understanding their value, They realise that due to the fixed focus on costs, cost-plus pricing and operational efficiency, the value that they offer has diminished over time. It can be quite intimidating for businesses to realise that, recently, all their investment has gone in the wrong areas. Product innovation is very limited product innovation. They've stagnated the value and innovation in the market. What does that mean in terms of their pricing power? Well, it limits their pricing power.

I think sometimes people look for-we've heard this term so many times-"a silver bullet". People are looking in life and in business, an easy solution to everything. Sometimes value-based pricing is sold as a silver bullet. I'll be honest. I think so many businesses, certainly B2B, but also B2C, are going to face tough price increase discussions with customers. Whether or not this week or next week, but certainly in the next couple of months. Because fundamentally, you can't absorb the cost increases we're seeing and keep costs flat. These conversations are going to be super tough no matter what pricing methodology you use. Because, like, fundamentally, certainly, if you're a cost-plus business and you focus on low cost and you have an articulated value to your customer base, they see you as low cost, and they see you as a commodity supplier, as well as cookie-cutter and all those sorts of things. In theory, when you come to them with a letter saying that from July 1st the price will increase by 15%, or whatever it is, that's a completely plausible number. At the end of the day, a very large number of these customers will go out and look at alternative suppliers. You will lose some revenue. You will lose some customers because we all know how things work. You’ll go out, you’ll shop around. You could potentially get a lower quote from somebody else. If they don't really value or understand the differences and think you're commoditised, they will get a lower quote. Whether that quote is realistic or sustainable, it doesn't really matter. A certain percentage of customers will go to this. And so the guy would say, in this environment of high inflation, we're going to see higher churn on a customer basis. We're going to see more customers shopping around. It tempts people to use the old bait and switch. A lot of competitors will offer you a low rate and then increase your prices later on. Because fundamentally, it's better to have you in the door than not to a large extent. But I think if you focus on value-based pricing over time, or at least move towards that, understanding or having a concept of your customer's real value drivers, you can discuss this with him, and work with them on that basis. Whether it's through key account management or whatever it is, I think you'll have a better chance of keeping customers. You have a better chance of minimising that churn. At least try to keep the conversation. What's the old saying? I think it's the CIA hostage negotiator thing. When the hostage-taker asks for something, it's always, "How can I do that?" How will I do that for you? It's that sort of conversation. It's like, of course, we all want prices to stay rock bottom. Everybody wants the price to stay flat. But if you can get to the next step, how will I do that for you? How would I minimise the cost? How will I increase your value? Getting that conversation started, I think, is a real step. If you're purely a commoditised player, purely cost-plus, you probably won't even get to the first part of that conversation.

I think another drawback of cost-plus during times of inflation is that you really see how both customers and organisation businesses basically don't segment their customer base. They treat all customers the same. We find this is certainly the case when companies utilise a cost-plus system. They think well that that's enough, we'll get enough margin doing that. They don't think about the differences between customers. And, they don't think about, how customers buy? Why do they buy from them? So in terms of inflation, what happens when you don't have customer segmentation? Well again, it’s knee jerk reaction. You think "Okay, I'm going to take as much business as possible. I'm not going to discriminate, we need more volume, we need more business in." But not necessarily thinking the supply. Do we have the raw materials to supply these customers? Are these customers ordering enough from us to warrant the margin? Is this business covering our costs? Often you'll find that the answer is no. Companies are accepting all types of business. Small accounts and the machinery the uptime and the setup costs are quite significant. Then they end up literally selling below cost. Not only would they do that in an environment that isn't experiencing rising costs. Not having the segmentation is critical to businesses but yet it's something that's not really considered.

I think like the old saying self-fulfilling prophecy. People and companies who focus on being the lowest cost, being the cheapest. Being the lowest cost in the market all that sort of stuff you're making a rock freeroll back to some extent. That's all great but then exchange rate movements, so many things are out of your control. So many things, who knows what it could be? It could be a truck breakdown, it could be a road, train system collapsing. Or it can be anything that can really disrupt international trade or access to commodities or whatever it is. That's a cost input to you. When you're selling yourself. When you're presenting yourself. And when you're negotiating purely based on the cost that is what you'll be seen as and that is where the discussion. It'll be harder for you to swap when the wind changes and you want to be discussing value, additional value, reasons why you have to increase prices. It's harder. In the past, if you've started to implement increasing value to customers. Understanding the segmentation as Joanna mentioned those systems. If you're starting to do those, integrate immediate cooperation, upscaling your sales team to do that. Those conversations will be and I'm talking about this is marginal. It's gonna be marginally easier. Hopefully, you will maintain that you will have a lower level of churn come with the price race goes through. You are still gonna have that because I suppose in inflation, people have always talked about how destabilising. This is the wider economy, inflation is destabilising. It undermines societies. A famous example is Germany of World War One, isn't it? Whereby it basically undermine the Weimar Republic or whatever it was called. It undermines people's ability to compare prices, to compare value, to compare offers. When you see that, obviously we're at a much lower level. We're talking 10% versus 1000s of percentage but it still has flow-on effects. It will impact, my predictions for this year it will lead to increased churn. It will lead to tougher and less pleasant discussions with customers. It will lead to potentially lower profitability in many B2B businesses. Because you probably won't be able to push through all the cost raises that you want to and you will be squeezed. There will be a squeeze in the middle. How long did this inflationary period last? Who knows? But I think it's the old saying that Warren Buffett, "when the water goes out, you see who's swimming naked". A lot of companies have been stripping out their sales team, stripping out that marketing, stripping out the expertise. They will be hurt the companies who have been putting more effort into articulating, increasing value, making better products, having better relationships with customers. You'd have to think there are no guarantees, but you'd have to think they would benefit.

Yeah, I think so. Because I think especially in B2B, your customers are experiencing the same type of pain as well. At the end of the day, they do understand the pressures that you're under, however, has to be communicated to them. And often we find that because businesses have stripped out all that sort of the growth functions in their business. Not all of that may potentially be 50% plus. They end up not communicating well with their customers. They don't give customers the communications that they need on price rises. Changes in the business model. Even exciting news about successes. New assets that are going to generate more value for customers. Literally, there's no communication. There's one thing that customers don't like, people don't like when there's a lack of communication. And there's a high need, they need that product. They need you to supply them on time. They need to know whether there are going to be long lead times. Then there's nothing. There's no explanation of why things are going wrong. There's no explanation about anything and then there's whack, there's a price rise. Because in your mind, Yes, you have to give the price rise to cover your costs to manage inflation. And, if only had you communicated that in time to your customers, they would have understood it too. But really all they've heard is a price rise, nothing else. So often you've got to really think about people's talent, pricing strategy, all at the same time. Unfortunately, there are a lot of problems in that it's hard to fix. It's not a quick fix solution. And as Aidan says, if you haven't made the time and investment in really setting up your business and business model properly. Then you're going to be exposed in the sorts of times and it doesn't matter. No matter how hard you try to cover that with cost tracking and new calculations on costs. That's not going to fix the problem. Because you may have covered your actual input prices, commodity prices that might have been covered in the new price increase. But you're still falling short because your go-to-market strategy is misaligned with the market. That could be the biggest margin erosion not rising commodity prices.

I think I leave it probably on a negative note. Nothing like a negative note before the weekend. Maybe it's just the weather in a bad mood. What I say is I think customers understand, everyone knows there is inflation customers understand. But it certainly if you're dealing with procurement and as we know procurement teams are becoming more and more short term they’ll becoming implementation and tactics versus strategy, as opposed to strategy longer-term stuff. And if you haven't built that longer-term value story, they will understand but fundamentally won't care. They will understand but they will take advantage of you and it's appealing to their best interest on their best hearts. I don't think it's really going to cut the mustard. So yeah, I forecast in more churn, it is going to be a bit of business pain. It's going to be tough. I think, yeah, it's going to be certainly tougher for the weaker companies with the weaker pricing strategies. But I suppose on the positive note, on that same fact, the better companies will benefit. As churn increases, they will keep more and probably win more. So you got to look at it in that way too, the swings roundabout.