Pricing in an Economic Slowdown

According to the National Bureau of Economic Research (NBER) in the US, the definition of a recession is “a significant decline in economic activity spread across the economy, lasting more that a few months, normally visible in real GDP, real income, employment, industrial production and wholesale-retail sales"1. The more commonly accepted definition is two consecutive quarters of falling output.

It may still be a little too early to tell whether economies like Australia, the US and the UK are officially in recession or not, but either way, it is time to start thinking about and preparing your pricing strategies for use in a possible economic downturn.

Several articles have recently been published on how marketing strategies should be adapted for an economic slowdown, but they hardly, if at all, touch on how pricing strategies should be modified. In this post, we seek to redress that situation.

John Quelch from Harvard Business School wrote about strategies for an economic downturn in a recent article in The Financial Times2. He makes a number of good marketing –related recommendations. Below, we reprise those recommendations and go one step further, drawing out implications from a pricing perspective:

Recommendation 1: Focus on Quality

The Rationale: Companies that cut back on the quality of their products and services may find it comes back to haunt them when the economy recovers.

The Implications for Pricing: If you want to, or have to, reduce the quality of products and services, adjust your prices in the same direction as well.

Recommendation 2: Close under-performing areas of the business

The Rationale: This can apply to retail locations, as well as to products and services. It may be better to proactively rationalise now, rather than having to take a reactive, broad-brush approach later. Locations, products and services that are candidates for such action include those that are unlikely to rebound when the business climate improves, based on a re-forecasting of demand.

The Implications for Pricing: If you scale back your retail or trading locations, or your products and services, provide alternatives or transitional arrangements for those customers who may be adversely affected.

Recommendation 3: Buy up financially week competitors

The Rationale: The cost of acquiring financially week competitors may be significantly cheaper than it would be in times of economic prosperity. Particularly attractive will be companies whose customers currently don’t buy from you.

Implications for Pricing: M&A activity provides enormous pricing opportunities in terms of the added value that the merger may create. This should be capitalised on.

Recommendation 4: Expand relationships with customers

The Rationale: In the interest of cost efficiencies, companies will be looking to consolidate suppliers during an economic downturn. It is not a time to cut back on market research, as in times like these, it is even more important than ever to understand customer price elasticity.

Implications for Pricing: Companies should also consider long term supply contracts, and potentially (cost-effective) loyalty and retention programs.

Recommendation 5: Support Distributors

The Rationale: The business model of distributors can come under a great deal of pressure in times like these. Any initiatives that reduce their working capital or excess inventory requirements should be favourably received. Companies may also consider dropping weak distributors.

Implications for Pricing: It might be worthwhile thinking about support measures for distributors, such as early buy allowances, extended finance or improved returns policies.

Recommendation 6: Understand competitors costs structures

The Rationale: As they say, “you’re only as smart as your dumbest competitor”, and some competitors may attempt a market share grab in difficult economic times.

Implications for Pricing: Understand the impact of price wars and price reductions

Quelch does have some specific recommendations around pricing. Recognising that customers will shop around more, he suggests temporary price cuts, reduction in quantity discount thresholds, extended credit facilities, and more aggressive pricing on small-sized products.

There are a number of pricing and advertising additions to these suggestions. Firstly, those temporary price cuts and reductions in quantity discount thresholds should be for a fixed and defined period of time, not for an open-ended duration. The last thing you want to do is condition you customers to cheaper prices infinitum. In some industries, such as mortgages and mobile telephony, customers might look for invoicing and budgeting certainty and switch to fixed interest rates or capped phone plans. Make sure these prices are optimised sooner rather than later. And finally, if there is still money left in the advertising budget, consider spending it on price comparison websites (such as moneysupermarket.com) which is where the price sensitive customers will be looking for the best deals.

Another recommendation comes from a recent Business Week article3, which recommends companies increase financial and operational reporting frequency. This will enable you to monitor trends in sales volumes, revenues and costs, but also keep an eye on the number of days customers take to pay their account. If customers take longer to pay their bill, it might be worthwhile giving them a call, and re-thinking how you “get” your prices and possibly renegotiate payment terms and conditions.

Although the short term outlook for some sectors of the economy is not that rosy, strategies such as those outlined above can go some way towards easing the pain.

References
1 Anon (2008) “The long hangover” in The Economist, 12th April, pp79-80
2 Quelch, J (2008) “Family comes first when marketing faces tougher times” in The Financial Times, 18th February, p14
3 Anon (2008) “Don’t Let the Downturn Get You Down” in Business Week, 20th February, downloaded from www.businessweek.com on 2nd March 2008