Making Pricing Decisions

Making Pricing Decisions

May 17, 2021

An almost unprecedented global crisis affects us all. Everyone that emerges from this calamity will have a hundred tales to tell of pain and heartache, and of victories both small and large. Those in the manufacturing sector are no exception. Whether you’ve seen a drop in demand, an increase in late vendor shipments, increased price sensitivity, or competitors making moves that you just can’t, the pandemic has affected your business in ways no consultant or clairvoyant could have foretold. This has led to at least one important take-home: Decision-makers must re-evaluate how they handle sudden changes in customer requirements.

Most decisions, including pricing, fall into one of two processes: Fast/ Automatic or Slow/ Effortful. According to psychologist and economist Daniel Kahneman, these are the two systems of dual-process thinking; System 1 (fast) and System 2 (slow). The most common decision made to a negative event is the intuitive, reactionary, or fast response. But this is rarely the best course of action.

Based on available literature, the common reactions to a sales crisis are:

  • Drop prices to encourage spending
  • Raise prices to offset added costs
  • Value price added costs

While these options are the more normal, or fast, decisions for pricing, the more thoughtful, or slow, decision process are often the better resolution. The common thread in all actions is that the System 2 responses tend to follow a more practical application of sound economic and strategic thinking. With a more deliberate response, your pricing decisions can improve your strategic output to overcome the current crisis and weather the next one.

Dropping Prices

Let’s not mince words. This is largest economic contraction since the Second World War with the largest number of economies seeing a drop in per capita output since 1870. This means that while in previous recessions there was a number of unaffected countries, this time everyone is making less.

System 1

As a decision-maker for a manufacturing company selling to the public, your first thought will likely be to lower prices to encourage spending. These price drops are usually in the form of temporary discounts that are clearly worded as such for the benefit of your customers. The plan being that once “this whole thing is over”, prices can comfortably return to their normal levels.

System 2

As a snap decision, this makes sense. But maybe this needs to be examined more carefully based on the types of product you are selling.

Studies have found that when incomes decline, demand increases for low-budget items. Meanwhile, the average, or normal items see a decrease in demand. This means that a blanket discount for all products is not the way to go. Keep the discounts to the average items while leaving the low-budget items as is. Then, when spending bumps again, you may bring some new customers that couldn’t afford your average or higher end products into the new tier.

Another possibility is to decrease the cost of the product, while increasing the cost of ancillary services. For example, decreasing the cost for the part but removing a ‘no questions asked’ return policy.

Raising Prices

I’m sure we’ve all see the plexiglass covers, or the added cleaning stations at numerous businesses. An unseen example of added costs can be seen in the increased difficulties for international trade. Between the added costs and a drop in sales, your company may be seeing red ink on the balance sheets for the first time in years.

System 1

Your first decision here is to raise the price of your goods and pass the added costs and lower sales on to consumers through higher prices. This may instead lead to a drop in revenue due to an even larger drop in sales.

System 2

Upping the price doesn’t take into account other factors. Adding cleaning stations or partition screens might bite into your profits but if your pricing was optimal before the crisis, your books should be able to allow this dip without a negative impact down the line. What you should focus on is how much cost is added to the price of the part after the initial setup. Prices shouldn’t require an increase unless the marginal cost also increases.

In other words:

  • If the loss is due to a marginal-cost increase (the price to make a good), raise prices.
  • If it is due to a drop in demand and the company has excess capacity, decrease prices temporarily.
  • If it is due to a fixed-cost increase (like a one-time cost in shielding for reception), do nothing.

Value Pricing

You may have added some ‘freebie’ services for your B2B customers during the pandemic. Stuff like free shipping, or no-charge same day deliveries. As things get back to stable ground, you will have to address those gifts.

Maybe you want to let it ride because you know your competition isn’t taking the foot off the gas, so you have to keep those services on your balance sheets to ensure you don’t lose business.

System 1

Doing nothing is definitely not the way forward. You might even think of applying value pricing, since those services at no cost were sold as a temporary add-on. This can be a non-starter if your service or product has competitors that are still offering those freebies.

System 2

A better option for repeat B2B customers, where the service contracts are transparent, could be end-of-year discounts, based on the number of times the service isn’t used when compared to the previous year. This leads to a win-win scenario. Customers get a benefit from the regular orders and a bonus for properly planning to have less rushes. And you start rewarding improved behaviour.

Don’t Sit and Wait, Innovate

The final option in times of crisis is clear. Creating and offering new products and services for which there is a sudden demand. Many companies have seen success with a shift to a different market segment by taking advantage of their current material and infrastructure, like food delivery, cleaning products, or shipping goods over passengers.

System 1

The first reaction may be to think this is anecdotal evidence and that there is no hole that you could fill with your capabilities.

System 2

Here is where dynamic capability and strategy come into play. This school of thought teaches that your corporate strategy should be driven by your resources and competencies. By knowing these, you will know your company well enough to see where a small tweak can open up new markets.

For example: Hockey equipment manufacturer Bauer switched their production lines to produce face-shields. Breweries and spirit makers started to supply hand sanitizer. Some passenger airliners started shipping goods. The Red Roof Inn hotel chain started to offer a “Work Under Our Roof” program where workers could book a room for the day (8am – 6pm) to get work done away from home in peace, quiet, and safety.

Conclusion

Engage System 2 thinking to analyze the problem instead of reacting. Look for strategic ways to solve a current problem and create a long-term competitive advantage. By having a single point of truth in data, like you get from OnRamp ERP system, decision-makers like you can make well thought-out, and long term, decisions based on solid economic and strategic principles.

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