Friday, April 23, 2010

Pricing In Our Current Environment

Pricing is a very complex discipline even during periods of economic growth and stability. With the onset of increased economic uncertainty and volatility over the last few years, pricing's complexity has significantly grown.

Of course, it is impossible to characterize all firms as having the same pricing issues, as each industry and firm has a different set of circumstances. As well, any substantive discussion of pricing, especially in today's economic environment, would be exceedingly lengthy and complex. However, there appears to be enough commonality among past and future pricing issues as to allow for some general comments.

Many aspects of today's economic environment are negatively impacting pricing and profitability. Among these are outsized excess capacity and generally weak, if any, revenue growth. As well, many firms are encountering customers unwilling, and/or unable, to pay previously acceptable prices. Inventory issues (mentioned in the last post), forecasting complexities (discussed in this article), and recent steadily increasing commodity costs further complicate the situation. While many larger firms have been reporting strong profits, much of this profitability has been attained through cost-cutting and other related measures. As such, it is not necessarily profitability derived through "pricing power" and increased gross margins.

Many firms have responded to the current economic environment by reducing prices. Much of the heavy discounting and promotional activity appears rather indiscriminate in nature.

Although cutting prices is perhaps the easiest way to attain revenues, this tactic likely holds even greater danger now than in the past. Gauging the effectiveness of pricing decisions is often complex, especially when viewed in a strategic sense encompassing multiple time horizons. While pricing decisions made now can appear proper, continued economic volatility and uncertainty can serve to undermine the effectiveness of such pricing. In essence, what may appear to be a proper pricing decision now may radically change with changing economic conditions. The odds of inadvertently managing a firm into some type of adverse pricing situation (or trap) like a "price war" or other various profitability-depleting scenarios is increased with greater economic uncertainty as well as customers who are increasingly price sensitive.

Although the current economic environment holds significant peril for pricing and profitability, there is upside to the situation. Those firms that can effectively manage pricing in such an economic environment stand to gain significant competitive and strategic advantage across many different business functions - not to mention significantly increasing revenue and profitability when viewed against a scenario of ineffective pricing management.

SPX at 1208.67 as this post is written

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