Sunday 15 June 2008

Pricing Strategy in an Inflationary Environment

While the recent hike in fuel price would certainly increase the cost to run your business, another factor that would create challenge to entrepreneurs would be how to price their products and services. In as much as we would like to pass the increase in cost to customers, this may not be feasible in all circumstances.
How do you develop your pricing strategy in an inflationary environment?

Consider the following three factors.
First is to establish whether your target market is price sensitive or not. If the market is mature, that is when you have a lot of players selling more or less similar products or services, then there is a high chance that pricing would be the determinant when customers make their purchasing decision. Pre-paid handphone card is an example. We can find outlets selling pre-paid cards almost everywhere now days. That's why the margin for the re-seller is very thin. Under such circumstances, increase in pricing would results in customers moving to the next cheaper competitors. Higher price would also exclude certain customers who may not afford to spend on your products anymore.

Second is to consider the impact to your cost structure and the cost of your competitors' products and services. Are they having the same problems? Any of them coming up with new sales strategy which will eat into your market share? Can you use this as an opportunity to differentiate your business and gain more market share by maintaining your present price level by controlling cost?

Finally, look at opportunities to re-package your products or services in such a way where your customers would have similar or better deal and you are not worse off.

Once you understand how the increase in fuel price impacts your customers, your competitors and your own business, you are in a better position to decide the way forward. The idea is to at least maintain the gross profit margin of your products.
Let's look as the following example for us to work out the pricing strategy.
Say presently your product is selling at RM 100 and your cost of sales is RM 80, your profit margin is RM 20 or 20%. If your cost goes up by 10%, that is RM 8, your margin is now RM 12 or 12%. For you to maintain similar gross profit, you have to sell your product at RM 167 to get back RM 20. How do your get the additional 67% in sales?
Your options are:
  1. Sell the product at RM 167. However, can your customer absorb the increase in price or would they go to other competitors who are selling at lower price? One way to commit your customer for an automatic increment in prices is to have a "price escalation clause" in the agreement with your customer.

  2. Increase your price by lower amount and you absorb the different. Here, is your business able to withstand lower profit margin?

  3. Sell more of the same product to get back the margin. For example, you need to sell 2 units at RM 100 each to get back margin of RM 24. You could, for example, offer volume discount to encourage customers to go for higher volume. The challenge here is whether the market can absorb higher sales volume and whether there is capacity to purchase on the side of the customers.
From the above, the better risk mitigation measure is to prevent a huge increase in production cost in the first place. If cost can be contained through better purchasing strategy, using alternative materials which would not result in decrease in quality, higher productivity or re-engineering of your production process, the pressure to recover margin through price increases would be reduced.

Do you really know the cost of your product or services? Well, if you do not have this information, your decision making may not be reasonable and as demonstrated above, the risks to your business would be higher.

Under the present circumstances, all businesses are calculating the impact of the increase in the fuel prices and working out their responses. If you are still not sure at this stage of what to do next, that is the sign of close and present danger!


Anonymous said...

Dear Nik

Your post actually reminds me of how was it like when i was doing costing last tym at my previous company..although it's no more related to what i'm currently doin (but i guess it is related to our life, now n forever), i certainly like to keep myself updated with the useful, thanks so much for this useful info.

The best mitigation for me is still to revise, lower your production cost but say say only is easy, i had a quite an experience trying to revise the production cost, doing the value added/value engineering last tym...

And having to compete the price with the competitors somemore...
Above all, what we can do is to maintain the quality and make people/customers believe in us ..

and how to do that? one way is by recognition of course..having the ISO status is a big achievement and useful in maintaining the company's market share.

Hasyudeen said...

Hi Elle, thanks for dropping by and share some of your experience. It is really challenging to cut cost and add more value! I never say that it is easy.

My point is more of understanding the implications and prepare your business to face the challenges. Some people just continue with business as usual, and finally they would face the usual outcome, business failures.

I wish you the very best of luck and I trust that you would share this blog with your friends.