What Inflation means for Pricing and Revenue Management

Introduction

Inflation is on the rise. Rates in the US rose sharply as the economic recovery accelerated. Consumer prices rose 4.2% in the 12 months to April, up from 2.6 % in March, marking the strongest increase since September 2008. Inflation is a scary thing for most companies – especially regarding their pricing. But there are unique opportunities that come with this challenge.

It is like in Formula 1:“If the sun is shining a good driver can overtake one car per round; if it is raining, he can overtake ten.” 

Competing in today’s environment is much like race car driving. If conditions are normal, the differentiator is your car – or in your case the overall condition of your company. But if conditions are difficult, it all comes down to the skill of the driver – or in your case the agility and preparedness of the revenue management and pricing organization.

In a nutshell: Inflation is a value-opportunity for great revenue managers and companies to move ahead! But why is that the case and how can you stay ahead of the curve?

Why inflation is an opportunity and a challenge for pricing and revenue management?

Whilst product and price decisions are always impactful, in normal times, an equilibrium has developed in mature markets. One sided deviation from this equilibrium – especially changing prices – is often not possible. External shocks – like inflation – disrupt this equilibrium and open opportunities. 

Three main factors add dynamism:

👁️‍🗨️ Customers change their behavior: Customers more likely change their spending behavior or their price sensitivity for certain goods. This is highly dependent on the category and on how incomes grow compared to inflation. Figuring out the dynamics at play in your industry and region is key to making the right decision. 

💰 Costs change: Depending on your industry, your costs of goods sold (COGS) are influenced by inflation. If you produce bread, for instance, an increase in flour costs are a challenge because customers do not care about your costs! You need to optimize your pricing given both costs and price sensitivity. Being able to do so is the key to success in pricing amid cost inflation. 

🆚 Competitors change prices, promotions or products: Inflation is an exogenous event which affects most of your competitors in similar ways. However, they will not all react in the same way, nor will their actions have predictable effects. Your competitors’ changing of prices or pack sizes is one of the most important factors to bear in mind when pricing; consumers will decide between you and their next best offer. As competitor prices changes become more frequent and more pronounced the new situation with new opportunities and thread needs to be understood quickly.

To emerge stronger in this new situation three steps are necessary:

1. Diagnosis: Map the New Territory

• Understand and quantify customer behavior changes.

• Understand cost changes and its implication on your product cost and margins.

• Gather information about changes in prices, products and promotions of your competition and understand its impact on your offering.

2. Guiding Policy: Approach to harvest opportunities shown by the diagnosis

• General guidelines how to deal with the new situation.

• This can be existing guidelines or new ones. E.g., focus on market share in segment A; No price increases higher than x%. At least y% below competitor A.

3. Coherent Actions: Concrete steps

• A set of concrete actions to benefit from the opportunities found in the diagnosis considering the guiding policy.

• E.g., offer product X in channels A and B; Increase price of product X while decreasing price of products Y and Z; change promotion Y for product X on channel A

The challenge to follow through are mainly in steps 1 and 3. Diagnosis: Even though data is available, the tools to make sense out of it are missing. This is particularly true for customer behavior. Coherent Actions: Decisions are avoided due to high uncertainty about how customers will react to offer changes. There are no tools providing clarity on market reactions.

The shortcomings of existing tools are in particular:

👁️‍🗨️ Customer behavior is oversimplified: Excel-based models as well as “leading” pricing software often use elasticities or cross-elasticities. As you can read in our blog on the topic, elasticities condense consumer preferences down to one number. The more change in the market the more error elasticities and cross elasticities include.

💰 Costs are not harmonized with prices: In most pricing solutions, costs are not properly harmonized with prices. They either get too much weight e. g. in cost-plus pricing or too little e. g. in elasticity-based pricing. As most professionals know this they put different weightings or averages on these factors which does little to avoid big errors.

🆚 Competition is largely ignored: Most pricing solutions are unable to measure how you should position yourself next to your competitors. As with costs, professionals often end up averaging or weighing competition as a factor based on gut feeling or isolated studies. However, as competition changes their portfolio more often, these generalizations become less and less accurate by the day.

In summary, inflation brings a lot of opportunity but is challenging to exploit using today’s tools. But how can you succeed in leveraging inflation as a competitive advantage?

How Buynomics helps you succeed in pricing and revenue management amid inflation?

With inflation a realistic long-term prospect, the imperfections of current solutions are becoming evermore evident. 

At Buynomics, we realized that an ever-faster changing world requires a new solution. We leverage a clever machine learning algorithm to simulate how your customers react to real-life price and product changes. This novel approach does not rely on price elasticities and avoids the pitfalls of current models which require gut feeling to average and weigh different factors into a holistic picture.

Instead, Buynomics enables you to succeed in pricing amid inflation through four key functions:

⚡ Immediate feedback on changes in buying behavior allow you to better tailor your offering to consumer needs.

🖱️ One-click price optimization enables you to find the best price regardless of the market circumstances and given your cost structure.

🚀 Portfolio optimization features enable you to use pack-size and product array as a lever to succeed in pricing.

🙌 Including competitors as well as your own costs gives you a holistic picture of the context in which you are operating. 

These benefits are possible thanks to novel technology which makes Excel and elasticities redundant. But how does Buynomics come up with those insights? By combining behavioral models and customer-specific data, we create an accurate model of your end consumer, allowing you to predict their actions and optimize accordingly.

Figure 1: Buynomics combines behavioral models and customer-specific data to create an accurate model of the end customer

This makes the Buynomics machine learning solution for the revenue manager of tomorrow – for a business that is not only more dynamic, but more profitable as well.

Do you want to learn more? Watch our webinar on how to tackle inflation with the right pricing approach or download our free infographic on Pricing Amid Inflation. 👇