new options in the inflation fight

Managers should consider these three strategic options, especially if inflation persists: recalibrate and clean up the product portfolio, reposition the brand, or replace the price model. These options are not mutually exclusive, so managers could also pursue a combination of them. There is no need to give up anything. All models can be implemented concurrently.

Inflation is not a problem today. It is a very comfortable opportunity for managers. Nowadays, companies have several ways to implement this option. They can bundle or unbundle existing products, either to create new value propositions or to expose customers to lower price points for the disaggregated goods and services they want to buy. They can draw on insights from behavioral economics to change price gaps in order to steer customers toward more profitable offerings. Depending on what they have in their R&D pipelines or how flexible their production capacity is, they can also introduce less-expensive alternatives or, introduce higher-end products that make the existing product line appear more affordable.

addressing customers’ real sensitivities

When thinking about inflation, managers tend to overemphasize price sensitivity as the key factor in determining how customers will respond to any changes they see. But they should keep in mind that customers are also quantity sensitive and quality sensitive.

If customers are more price sensitive than quantity sensitive — as research shows they are — they are less liable to notice a price increase in the form of a smaller quantity at a constant price. Quality sensitivity comes down to the features that customers could live without or accept at a lower level. If a product or service has several such features, managers can consider whether removing or adjusting them creates opportunities for new versions with fewer features at a lower price point. The converse also holds true. Slight changes in quality can unlock a much greater willingness to pay without a significant increase in costs, allowing the company to establish new offerings at the higher end of the market.

At any given time, most offerings are either overpriced or underpriced — in some cases significantly — relative to the value they deliver. A wave of inflation offers managers an opportunity to correct these misalignments in their product positioning.

Let’s start with overpriced products. When a company is investing large amounts in marketing to maintain or prop up a value proposition that is becoming increasingly tenuous, a price cut can make sense. That can happen when an offering is losing its competitive edge or was priced too high from the outset. Inflation makes it riskier to maintain that position. The company can solve this problem by reducing marketing expenditures and lowering the price at the same time to support a more realistic positioning. Depending on the magnitude of those changes, the moves could even lead to higher profits.

The more common situation, however, is that a product is underpriced relative to the value that customers derive. In that case, the uncertainty surrounding inflation, combined with customers’ expectations that they might need to pay more, provides an opportunity to change communication and position a product in a higher price tier. That opportunity is especially promising when the company has relied on low prices as a source of competitive advantage.

Intrigued by the success of subscriptions and “my-product-as-a-service” models, many companies have already considered adopting new price models. The immediate need to respond to inflation gives them a compelling reason to implement these plans now and avoid needing to settle for the littlest of three evils in the classic trilemma.

One drawback to the “raise your prices” answer to inflation is that you might lose customers who can’t bear the higher costs. But is it worth losing any customers when they might not be “bad” customers (whatever that means), but victims of an outdated transactional model that restricts their ability to try and use your product? Access, consumption, and outcome-based price models allow more customers to buy and use what they need from you, when they need it, rather than tying up their money in expensive assets or foregoing the inputs they need to develop better products at their own speed and scale.

New pricing models often sacrifice the upfront revenue impact of big-ticket sales, but they generally make up for that with higher recurring revenue over a customer’s lifetime. Investors tend to find these revenue streams more attractive because they are predictable and because they spread risk over a wider basis of customers

Conclusion

That final point is what makes new price models a strategic decision rather than a tactical response. In 2013, Adobe switched from selling its customers perpetual licenses via plastic discs in boxes to selling them software access via a monthly subscription to its Creative Cloud. During the adjustment period, the company absorbed slight declines in revenue and profit; but has achieved strong growth ever since. Opportunities exist for change: the food industry was negatively affected by inflation in 2022 and world inflation achieved 8.8%.

But with today’s data resources and analytical power, there is no reason why corporations shouldn’t explore an attractive strategic response to inflation rather than trying to choose between tactical price increases, margin hits, or reductions in quality. If companies don’t want to make a wholesale change to a new model, they can allow the new and old models to exist together and allow customers to self-select. Managers of all businesses should collaborate with each other in the world arena and find ways to solve the inflation problem and douse its risks. Inflation can also be treated as a strategic opportunity for innovations in risk management.

References

1. Gourville, J. & Koehler, J. “Downsizing Price Increases: A Greater Sensitivity to Price than Quantity in Consumer Markets.” January 2004. SSRN Electronic Journal.

https://www.researchgate.net/publication/228149855_Downsizing_Price_Increases_A_Greater_Sensitivity_to_Price_than_ Quantity_in_Consumer_Markets

peer-reviewed by

Dr. K. Srinivasa Rao

Author

Dr. Maya Katenova, Assistant Professor of Finance, KIMEP University. Maya teaches bachelor’s students as well as master’s students including Executive MBA students. She received a Teaching Excellence Award in 2017. Courses in her teaching portfolio include Financial Institutions Management, Ethics in Finance, Financial Institutions and Markets, Principles of Finance, Corporate Finance, and Personal Finance.

She supervised master’s thesis dissertations of several students and has numerous publications in different journals including high-quality journals. Her research interests are mostly related to corporate social responsibility and global ethics.

Maya holds the Professional Risk Manager designation and is planning to teach Risk Management in the future. Her future career is strongly connected with Risk Management conferences, symposiums, and workshops.