The roller coaster of price development has picked up speed and there is no end in sight. Everything seems to be out of balance. At the same time, the momentum continues to rise. The energy crisis is fueling inflation as the main driver and is mainly responsible for the persistently rising prices throughout the supply chain. Given this situation, the question is how do you best deal with the unrelenting rise in your cost structure? Follow us on a short journey to the most important aspects with room for maneuver – from communication to contracts and clauses to commitments.
It seems that the days of slow and rather predictable price changes and seasonal fluctuations are over for the time being. It feels like we are confronted with extremely volatile prices on a daily basis. In sum, a melange consisting of corona lockdowns and drastic changes in demand, production outages, supply chain blockages, war, and disruptive changes such as digitalization and sustainability is responsible for this.
The question of pricing strategy
Unsurprisingly, the question of pricing strategy is currently essential. So:
- What are your contract commitments and possible price escalation clauses?
- How “transparently” do you communicate cost blocks such as raw material shares, energy, etc. with your customers?
In the packaging industry in particular, high raw material and energy prices are significant cost factors that can very quickly eat up margins in phases of rising costs – and thus jeopardize your company’s ability to do business.
The question of price commitments in customer markets
Another essential question looks at your market or the market of your customer base. So:
- How does the market in which you or your customers are located behave?
- What are the contract situations there?
Often there are contractual commitments that guarantee price stability over a longer period of time. Or there may be price escalation clauses that take effect at regular intervals (annually, semi-annually, etc.). Or perhaps there are price adjustments that have been anchored to a fixed agreed threshold of a commodity index.
The question of changing energy costs
One of the most important questions in times of volatile but fundamentally rising commodity and energy prices is:
- Is there a lag in adjusting your prices to reflect increased commodity and energy prices? In other words, are you suffering windfall losses?
Only when commodity and energy price adjustments are communicated and “demonstrably” demanded in your markets can you set about adjusting selling prices on your part. By then, you may have already suffered a so-called windfall loss.
This term describes a margin loss that you experience during a price increase in one of your own cost blocks, without having been able to adjust your own sales prices (see chart). The counterpart to this is windfall profits, which occur in phases of falling costs in which one has not yet been able to reduce prices or has not had to do so.
The question of margin
At the end of the day, your product should (must) make a margin. Windfall profits and windfall losses should be in balance. But especially in phases of long-lasting cost increases, this is not the case; on the contrary, you run after the lost margins in the long run. The essential question then is:
- Can you cope with this margin loss in the longer term?
It is true that FMCG retailers can retender their “offers” according to their weekly advertisements. And certainly, sooner or later, there will be competitors in the market who will react by adjusting their prices, thus creating room for maneuver. But no one in the industry has the ability to adjust their prices on a daily basis as, for example, mineral oil companies do at their service stations.
The question (and answers)
How can you best deal with a continuously rising cost structure?
The answer: Live a focus on the following aspects.
- Best possible internal communication
- Your sales team should know immediately about the current costing parameters and, ideally, receive concrete guidance on the need for adjustments to the last price adjustment or price fixing.
- Best possible customer communication
Clarity about developments in the cost situation, honest forecasts and information create understanding and normality with regard to this topic vis-à-vis your customers. Providing information proactively and at an early stage stimulates discussion. This behavior must also take place in the case of price reductions, because otherwise you will lose trust. Specifically, we recommend:
- Communicate a concrete pricing strategy for the affected items to your customers.
- Talk about price adjustment instead of price increase.
- Communicate the advantages of the adjustment with tangible arguments, such as security of supply, quality, etc. This will create understanding for the current price adjustment.
- In this way, you create understanding for the current price adjustment and reduce the pitfall for future adjustments.
- Review existing contracts and price escalation clauses.
- In threatening situations, seek a discussion with the customer. At the end of the day, you both want to be sustainable and the customer also wants to be able to reliably purchase their products
- Do not make longer-term commitments on prices and include price escalator clauses. This point is important because inflation, for example, can also cause wages to rise very quickly. Transport is also a cost factor that is currently difficult to calculate. However, it must be clear that even a price escalator clause does not guarantee security. This is because there are always other factors that can lead to a price adjustment. Keep an eye on this so that you can cushion these uncalculated developments if necessary.
Crises are also the right time to work more closely with your partners. They are times when you can identify which “partners” are not interested in sustainable cooperation. In the end, this is also a valuable insight that can be incorporated into your further strategy as an important result.
Furthermore, you should not forget that crises and cost increases also affect the other market participants. In the end, we have to master these volatile times together. If you manage to overcome the difficult times with your partners and customers together, fairly and in partnership, you will also strengthen the relationship for a future when things will be calmer again.
And last but not least: What you acquire today in terms of flexibility, resilience, good communication, stringent behavior, functioning tools and trust will also benefit you tomorrow, regardless of the crisis level. It will help you maintain your lead over the competition and get fair value for your services.