Consumer companies are being confronted with inflationary cost pressures on many sides. The costs of many raw materials and agricultural commodities are on the rise. At the same time, shipping costs have soared and wage rates are moving higher. In fact, the July 2021 Producer Price Index showed input prices have increased 9.6% in the past 12 months after spending most of 2020 in input price decline.1 While some cost increases may represent only a transitory shock, others are likely permanent, and these costs may contribute to eroding margins.
Taken together, these factors are creating a highly inflationary environment—conditions not seen in more than two decades. In fact, analysis shows that as of August 2021, S&P 500 companies have mentioned inflation in public statements with a whopping 1,100% increase in frequency year over year.2
Recent financial results from consumer companies further highlight the importance of inflation in the minds of management teams (and investors). After reporting Q2 earnings in August, several blue-chip consumer companies saw 10%+ drops in share price when they discussed inflationary cost pressures without corresponding offsetting pricing actions. This pressure was not fully offset by comprehensive, proactive pricing actions, adding further concerns to near-term margin improvements. By contrast, several major food and beverage companies have experienced recent share price outperformance by announcing aggressive (but nuanced) pricing actions. These actions include list price increases, price pack architecture, and consistent public communications across the majority of their portfolios.
While CMOs and other C-suite leaders recognize the need to raise prices in the current environment, they also worry about volume losses and consumer retention. If done well, now is the time to adjust prices, not only to address cost pressures, but also to harness new, longer-term margin opportunities (when cost pressures abate).
Consumers are starting to see these price changes manifest on shelves; the main measure of consumer price inflation, the CPI, has risen 5.4% in the year ended July 2021, and even the more “stable” index that excludes food and energy has increased 4.3% in that time frame. This suggests some consumer companies have already begun to react to inflationary pressures. Unfortunately, many companies lack a comprehensive pricing plan and tend to transfer the rising cost of raw materials via broad-brush price increases, a strategy which dilutes the efficacy of new prices. In contrast, by using a targeted pricing strategy during inflation, organizations can leverage the current environment to clean up mistakes of the past, establish measures to control inflation, and drive growth over time.
Navigate the storm with pricing management
So, what separates success from failure? Based on our experience shaped by hundreds of projects for clients across consumer products and other sectors, companies that are successful in implementing pricing strategies during inflation follow four specific steps:
1. Correct “less-than-optimal” pricing decisions made in the past
Focus first on “easy wins.” Use this opportunity to clean up your current pricing management strategy to communicate a clear market position to consumers:
- Adjust brand ladders and/or counterintuitive price pack architecture (e.g., value gaps across brands in a category or price parity between sizes)
- Remedy out-of-date (or create new) channel- and occasion-based pricing built on evolving consumer expectations
- Reduce over promoted items based on category roles or target the reduction of promotions with little incrementality
- Improve unprofitable or overfunded customers (or those that lack performance on specific trade or merchandising terms)
- Adjust service pricing and terms to be in line with the market (especially given a 30% to 50% increase in shipping over the past two years)5
- Reduce customer-specific SKUs that are unprofitable or not “marked to market”
2. Build a structured and targeted pricing strategy
Companies typically tie broad-brush price increases to cost inflation of the largest raw materials. A more effective pricing strategy leverages differences in product, channels, and customers to drive targeted price increases. Effective pricing strategies are anchored in value, price-sensitivity, and costs to serve in addition to raw material cost inflation.
When building a pricing strategy during inflation, considerations need to extend from product through channel to consumer.6 A strategy based on a granular and deep understanding of products and customers can result in higher actual price realization, better customer and consumer retention, and overall volume growth.
3. Communicate effectively, both internally and externally
Consumer companies need to support effective pricing management with effective communication. For example, anchor the price increase conversation in the context of value amid the current macroeconomic environment. Arm sales teams with robust data and analytics. Provide insights, scenarios, and potential impacts (including benefits) for retailer and consumer economics. Demonstrate dynamic, consumer-centric thinking; design and customize communication based on product-specific attributes and price points; and emphasize everyday value and occasions.
4. Rethink commercial positioning
The pandemic and related macroeconomic environment of 2020–2021 have created deep and far-reaching impacts on how consumers live and what they value. It is essential to understand how consumer needs have shifted (some permanently) and use the full suite of commercial strategy tools to manage today’s inflationary pressures and prepare for the potential top-line impact of demand shifts (or reductions) as new, postpandemic behaviors emerge. Rethink commercial positioning and reexamine brand, marketing, and packaging strategies, including potential use of nonuniform and, in some cases, nonprice mechanisms. Examples include:
- Expanding price architecture tactics
- Implementing “shrinkflation” (i.e., reducing product size or count to maintain price point)
- “Value-engineering” products, given consumer value perception (of specific attributes)
- Suppressing offers to specific channels or consumer segments
- Revising price zones and segments
- Refreshing in-store level assortments
Perceived pricing gains may be easily eroded over time through excess trade funding, poorly negotiated joint business plans (JBPs), price protection, and other terms. Companies should invest in the right tools, analyses, and processes to fully realize price in net sales.
The time to plan for price increases is now
Today’s economic climate and associated pricing management pressures present challenges not seen in decades; indeed, many junior brand managers and pricing teams likely have never experienced such conditions. Some companies have responded by announcing pricing actions only after investor or Wall Street scrutiny.
However, with foresight and careful planning, consumer companies can manage pricing margins effectively, responsibly, and profitably. Determining how and where opportunities exist to aggressively pass-through increases and when discretion is advised can help companies control inflation, drive growth over time, and remain profitable.