Peter Hatfield is a Director at Vendigital and recently shared his insights with The CFO.
High inflation and rising interest rates have been placing enormous pressure on businesses, leading to significant cost volatility, which has been testing their viability. However, with warmer weather on the horizon and energy prices starting to decline, businesses can breathe a sigh of relief as reduced energy demand may now offset the impact of the increase in the energy price cap, which is due to take effect in April.
Additionally, there has been a slight easing in the price of raw materials including steel – indicating that things are starting to move in the right direction. However, with cost volatility still a factor and ongoing uncertainty impacting consumer demand, CFOs will need to strengthen their resilience and become better at managing complex situations. They need to consider how to tackle the challenges faced when re-pricing is not an option.
They can do this by focusing on four key areas: improving the approach to price negotiations, thinking strategically about the allocation of trade and promotional spend, examining direct costs (including the potential redesign of products to remove costs where possible), and by seeking to develop a more flexible model for indirect spend.
For example, while any easing of raw material prices is welcome, peaks and troughs are still likely to occur, and decision-makers will be wary of locking in prices as the situation continues to develop. To tackle this uncertainty, CFOs should be looking at their sales landscape and the outlook going forward, which will naturally depend on demand levels in their main markets.
For those operating in more competitive markets, considered pricing will be crucial to retaining market share, and businesses will require a full picture of sales forecasts and predicted volumes to guide their decision-making.
Pricing – a balancing act?
Finding the right balance between increasing prices while striving to remain competitive, and absorbing cost increases to protect market share has become a key challenge for many businesses in the current climate. Getting this right, however, could bring wide-ranging benefits, internally and externally.
When considering whether to implement price increases, CFOs need to be aware of the potential reputational damage should customers feel that they have gone too far. However, they also need a plan that will enable the business to protect its margins going forward.
Before the pandemic, inflation was less than 1%, which meant increasing the price of a product was much less significant. Now it is over 10%, making it far more difficult to negotiate sufficiently on prices, and bringing more risk.
A weak negotiation strategy could leave a business up to 5% off target, directly impacting its bottom line. As such, increasing the frequency of price reviews is important to maintain internal oversight, and CFOs should also consider utilising third-party data to benchmark their pricing strategies against those of their competitors.
Power of data
Before a decision is taken to increase prices, senior-level decision makers should ensure they have as much data as possible about pricing levels and expected cost movements. As costs begin to soften, customers may be looking to challenge on price, so it is vital to have a strategy in place that will allow the business to negotiate on the front foot.
While lowering prices could seem counterintuitive, CFOs should consider this strategy if they have developed a new product for a new market, for example. There are risks attached, of course; however, the ability to drive sales in a new market to create significant market share could bring long-lasting rewards. For example, a luxury goods company could lower prices on selected products to gain exposure to a new group of customers and entice them towards higher-value items.
Alternatively, it may be possible to lower prices if order volumes have increased significantly, as part of a move to cement supply partnerships, along with simplified and/or improved trading terms. A further example is the recent extension of the £2 bus fare cap – an instance where lowered prices are intended to increase the number of bus journeys taken to help the industry get back to pre-pandemic levels of travel.
However, if profit margins are tight and CFOs feel unable to lower prices or pass on cost increases, there are other areas to explore. For example, by analysing how much the business is spending on promotion or trading activities, it is possible to calculate the cost of each product sale and then look for opportunities to reduce it.
The business could also explore whether it is possible to optimise existing trading relationships by shortening payment terms or persuading customers to increase order volumes to get better rates.
It is also important to take a close look at direct costs, such as the Bill of Materials, and consider if there are opportunities to redesign products, or switch to using cheaper materials, without impacting the quality of the end product. Indirect costs, such as those linked to facilities management, service contracts and property owned or rented by the business should also be considered carefully. Furthermore, by outsourcing costs such as marketing or IT spend, businesses could allow themselves more flexibility to scale up and down activity as required.
Decisions, decisions, decisions
Key to making the right decisions in today’s challenging and competitive trading environment is data strategy and its ability to shine a light on all areas of the business. CFOs need accurate and meaningful cost data about every aspect of their business to make considered decisions in a climate of continuing cost volatility.
Being able to rely on facts will help senior-level decision-makers in several areas, from negotiating with suppliers to maintaining oversight of the bottom line. This in turn will enable the business to adjust its pricing strategy accordingly to maintain profits and increase resilience. A solid data strategy will also help CFOs make better-informed decisions despite the uncertainty.
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