Rising import costs caused by a weak pound don’t have to mean squeezed margins, says Robert Browne, pricing expert and a strategy partner at KPMG in the UK.
It looks as if consumers are starting to feel the ‘Brexit pinch’. Since the referendum, most companies importing raw or finished goods were either protected against sterling weakness by currency hedging or simply swallowed the higher input cost.
But with hopes of a significant bounce in the pound fading and with hedging strategies on their last legs, companies face an unpalatable choice: absorb increased costs and accept the hit to margins, or hike prices and risk a consumer backlash. Or the third way – ‘shrinkflation’ – where you lower costs while keeping the price of, say, your chocolate bar constant.
To absorb costs or pass them on is the perennial dilemma for price setters. What makes their task different this time around is the speed and scale of the cost increases – and the fact they are generally coming through in one lump. Data from the Office for National Statistics show that input prices rose 20.5 percent year-on-year in January. Together with a possible slowdown in the UK economy this year and the risk importers could face a whole new layer of costs – namely tariffs on EU goods – that means we’re in a whole new ballgame. Welcome to pricing strategy … Brexit style.
Amid all the talk of preparing for the UK’s departure in 2019, Brexit is already making its presence felt in the world of pricing. And, after holding off as long as possible, many now want to hand the bill to consumers. Just this week, retail consultancy Kantar Worldpanel said like-for-like supermarket inflation had doubled in the 12 weeks to the end of February versus a month earlier.
I hope those retailers and suppliers asked the right pricing questions first: “Are we hiking at the right time? By the right amount? And in the right way? Can I afford to raise prices at all? Are we shooting too low?” I’m frequently surprised how often these conversations happen without the appropriate data and insight. Companies need to understand the true value of their offering in terms of its desirability and usefulness to consumers, relative to competitive alternatives. Effective pricing should never be a conversation that goes: “These are my costs…now what can I get away with in terms of margin on top?”
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First and foremost is understanding your pricing potential in the market. A Sunday newspaper might increase in price from £2.50 to £2.60 and the consumer feels that “it’s still good value for money”: that’s less likely to work for a generic washing powder. On some items, consumers will know the price almost to the penny: a cup of coffee or a pint of milk. Companies mess with these ‘known value items’ at their peril.
There is still a way to raise prices on these price-sensitive products. Companies might consider a modest rise now and then another in, say, six months, or perhaps by ‘layering in’ price rises through changes to promotional prices over time. And for those with stronger brand loyalty, reminding consumers of why they love your product or service, for example through an advertising campaign, might help ease through a price increase.
Ultimately, you won’t know your pricing potential unless you test it. Companies should experiment with pricing, by testing in a sample of retailers, geographies or channels. They need to be agile, and humble, to adjust their prices or introduce a new promotion if it’s not working.
Companies can easily feel a sense of despair and loss of control as costs increase, particularly if competitors are not suffering the same fate. In some cases that concern is justified and they need to ‘take it on the chin’ and look to take costs out elsewhere. But for most companies, they need to challenge whether they truly understand how much their customers value their offering, relative to competitors, and to harness the pricing potential they have always had.
One last thought: our EU exit, and the higher import costs and potential tariffs it could bring, effectively moves the supply curve and will make many products more expensive to produce here. That presents an opening for new or established competitors to innovate their business and operating models to compete more effectively. We can safely predict there will be winners and losers, and in time the losers may not survive.
Understanding your Brexit exposure over the next two years will form a key plank of your pricing strategy. But understanding your customers and how they value what you sell to them must come first. Get that right and companies have every opportunity to thrive.
This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG in the UK. You can register for the email subscription list of this column and expert views from our Brexit leaders.