In the past decades, high inflation rates mostly only challenged smaller, troubled economies like Argentina, Venezuela or Turkey. But with CPI prints now topping 9% in the US and the UK, and 10% on average for the 38 countries in the OECD, inflation now touches us all. And it’s not going away anytime soon.
As vulnerable consumer segments reach the limits of their wallet and more affluent consumers start to feel the squeeze as well, your company is likely struggling to maintain margins and please shareholders.
So, what can you do about this? In this article, you’ll learn a three-step process to mitigate the effects of inflation on your business. We share proven strategies our clients have adopted to successfully tackle inflation.
The common debate revolves around tactical solutions where higher Costs of Goods Sold are offset by higher prices, physical product downsizes or service downgrades. Walking this fine line has never been easy, even when inflation wasn’t an issue and consumer behavior wasn’t disrupted to the current extent. Now, the difficulty of the challenge has risen substantially, forcing us to look beyond the tactical solutions we have relied on for so long. We must go one level deeper to uncover more structural ways to move forward. Deeply understanding your customers, looking at the different needs of different people and always managing brands, products or services in the context of the broader portfolio, can help navigate the challenges of today.
Putting the consumer at the center
First, we advise taking a step back and looking carefully at what is at the heart of any successful strategy: the consumer. Do you understand how they behave and decide well enough to inform your strategic response to dealing with inflation ?
A strong product portfolio serves the needs of different market segments and capitalizes on different levels of willingness to pay for different groups of people. Some products might be able to carry a bigger price increase than others. Others might be able to capture lost share for consumers trading down within your category due to rising costs.
Does this still apply to your portfolio? Did some people get priced out? Or are you leaving money on the table for some, in an attempt to find an acceptable price for everyone?
Strong inflation has the tendency to disrupt categories, with consumers often no longer following their habitual shopping journeys. Instead, they are now forced to make more deliberate trade-offs and revisit product and brand choices that used to be automatic decisions. It is in understanding these decisions where we can find the first clues in how to adjust your pricing and portfolio strategies.
Consumer behavior questions you need to answer for sound inflation strategies
For each of the consumer segments you serve, we need to understand how they are affected by inflation. How severe was the disruption in their behavior and in what ways did they change their behavior? This bigger question of how your customers are re-evaluating their choices, can be broken down into a set of smaller questions:
- Are they running into price points they can’t afford anymore?
- Are they looking for different product or service characteristics?
- Are they skipping, changing or reducing usage occasions?
- Are they becoming more promotion driven in their choices?
- Are they downtrading to cheaper brands in the category?
- Are they switching to more affordable substitutes in neighboring categories?
- Are they using more affordable channels for their purchases?
Once we have answers to all these questions and more, we can start plotting the tactical and strategic responses.
- At a tactical level, prices and sizes can be adjusted in varying degrees for different brands that serve distinct consumer segments, each with their own willingness to pay. You may be able to perform gradual small price increases or size decreases to reduce disruption in the category and keep consumers in their habitual loops as much as possible.
- On the other hand, once consumers are disrupted in their behavior, more fundamental changes to your portfolio are needed to address consumers’ deliberate trade-offs in this new situation. This means taking a more strategic look at your portfolio. For example, new pack sizes could be introduced to better serve new usage occasions or facilitate the need for more value-driven pack buying. Entire price and size architectures could be overhauled to reset the value equation perception for consumers. Existing brands could be repositioned, or new brands introduced to serve as a safety net for the most price-sensitive consumer segment. Channel priorities might shift from convenience to supermarkets or discount stores. New product development efforts could start to develop more durable products that alleviate much needed pressure for so many, etc.
How to successfully manage your portfolio to mitigate the effects of inflation
When considering a more strategic response to inflation, we advise clients to follow a three-step process combining data analytics, forward-looking experimental research and a holistic approach to stakeholder alignment.
1. Analyze existing data and information to set pricing and portfolio direction
In today’s digital world, a vast amount of historical data is available to help us navigate these rough waters. On the one hand we have sales data from digital shopping environments or aggregated sales data from physical stores from suppliers like Nielsen, IRI or NPD. On the other hand, we have economic data on rising income gaps, product prices, wallet sizes, and saving levels. And of course, your brand will have a broad range of other relevant information sources (e.g. social listening, customer service, previous research etc.) to help us understand the consumer. These sources create a strong foundation to observe people’s actual behavior and form hypotheses around where certain solutions to dealing with inflationary pressures may lie. However, they also have limitations.
Although historical pricing and sales data can be used to assess price sensitivity and predict share changes for future price changes, these predictions get less accurate for higher prices beyond those observed in past data. But these higher prices may be exactly what your company needs to consider in today’s environment.
Similarly, based on existing data and insights, you may expect there to be a larger market for a smaller, more affordable pack size. However, that same historical data will not be able to tell you how successful such a new product might be, or how much it would cannibalize from your existing portfolio.
We basically don’t understand how consumers will respond to intended changes in pricing and portfolio strategies unless we can explicitly test these hypothetical scenarios. These applications are where experimental research like conjoint analysis shines.
2. Use forward-looking experimental research to test strategies
The main advantage of forward-looking research approaches, like conjoint analysis, over historical data, is that brands can evaluate new prices, sizes, variants, and other product features which don’t exist in market. We can test those items for which we have no available data yet. In a highly inflationary environment this becomes increasingly important as the probability that the prices are pushed outside historical ranges is extremely high. Additionally, more strategic responses to changing consumer preferences often require the introduction of new products, repositioning of existing ones, or other alterations to your current product offerings for which no historical data is available.
In conjoint research, a realistic set of products or services is presented to a large number of potential customers in fully controlled environments. In each of these virtual shopping exercises, people trade off the options available to them and select the one they are most likely to buy. Based on the information collected, a market simulation model is built that calculates the impact of different pricing, sizing and portfolio strategies on shares, revenues and profit at a product, brand and portfolio level.
Through the conjoint market simulation models, brands can simulate a virtually infinite number of “what if” scenarios and make data-driven decisions on how to best adjust your pricing and portfolio strategies to cope with inflationary pressure.
- Price elasticities will detail at a very granular level where the psychological price thresholds in the market are that cannot be crossed, and which products or brands need to go up or down in price and by how much.
- Source of volume analysis shows which other products, brands or categories people will switch to or from when new prices or proposition are introduced.
- Scenario analysis reveals the impact of your potential moves and what will happen if competitors do or don’t follow your moves.
While there is detailed information available down to the exact impact at a SKU level, keep in mind, the key to a successful strategy is looking at the portfolio impact as a whole. What is good for one product or brand might have a negative effect on another, reducing the overall effectiveness of that move. That’s why optimizations are always run at a portfolio level, to ensure that the recommended strategy maximizes returns for the company overall. Primary research with individual consumers in this phase can also be used to fill in any blind spots we still have in consumer understanding. We can focus on expected behavioral change in the new inflationary environment, in terms of usage occasions, promotions, downtrading, or any other aspect we felt wasn’t sufficiently covered by existing data sources.
3. Bring all key stakeholders together for alignment and activation
As you have most likely experienced, pricing strategies can rarely be set by one person or team alone. Many functions are often involved – from supply chain to sales and from marketing to finance. Therefore, we recommend bringing all stakeholders together for each pricing initiative as early as possible to align on possible strategies for different brands and market segments. It takes a multi-disciplinary team to assess which solutions are feasible both for the business and for partners such as retailers, and that bring value to consumers.
An effective way to achieve this alignment is by using a business wargaming session. Different teams impersonate different brands in the market and play “what if” scenarios in a competitive environment of actions and reactions, playing out a variety of potential strategies and competitive responses. During this interactive process, participants understand the impact on the business measured through a market simulation model. In addition, in these types of workshops, considerations from a variety of fields like brand management, operations, sales and finance are actively brought in. This creates more context into how different players are expected to act, why they might act a certain way and what strategies are feasible for the brand. With the different stakeholders on board, and all considerations and limitations taken into account, only pricing and portfolio strategies that can be realistically executed are formed.
Inflation is here, it is staying around for a while and might even become an integral part of our lives for the foreseeable future. This poses challenges for consumers and brands alike. From a brand’s point of view, placing the consumer at the heart of your efforts to manage inflation is key, and requires the following:
- Firstly, analyze existing data and information to set direction. Do we truly understand what drives consumers? What trade-offs do they make? When do their habitual patterns get disrupted?
- Secondly, use forward-looking experimental research to test strategies. For instance, leveraging conjoint-based market simulator models to make data-driven decisions that have a higher probability of success. Go beyond tactical price changes and work towards more effective and sustainable pricing and portfolio strategies.
- Finally, bring all key stakeholders together. The more strategic pricing decisions of today require a multi-disciplinary team to assess what is feasible, what is optimal, and to create buy-in on pricing strategies early on.
Following these steps, strategies that revolve around a deep understanding of the customer and can be realistically implemented by the business and by partners such as the retailer will be most successful in driving value even in today’s challenging inflationary landscape.
How is your team responding to inflation issues? We have the tools and experience to help. Reach out to our pricing and revenue management experts for a consultation today.