Alain Meloche, Global Practice Lead, Strategic Pricing for the Internal Consulting Group
While there is great uncertainty at this stage as to what, how large, and where tariffs will be imposed, one thing is certain: price adjustments will likely result.
To make pricing changes that best respond to this new environment, you need to take into account four factors:
1. Impact on Costs
As a first step, you need to think about the impact that tariffs will have on your costs. Two factors to consider include:
The percentage of your product costs that will be impacted by tariffs.
If you’re a small auto parts manufacturer such as metal stamping, your material costs are unlikely to be significantly affected by tariffs. In this case, suppliers will likely be domestic and they in turn are unlikely to face tariffs. On the other hand, if you’re a larger competitor such as Linamar with products crossing the border several times during the course of production, steel and other tariffed materials may account for up to 10-15% of costs. And, this depends on how many times the border is crossed, the relative percentage that the tariffed materials represent, and the exemptions to tariffs that are specific to the items.
Your supply chains.
If your supply chain involves sourcing from providers whose goods and materials may be subject to tariffs, you need to evaluate if and where there are alternatives. Specialized medical devices companies that depend on particular advanced sub-components may have few alternative sources. However, other companies such as food manufacturers may have alternate sources of supply. If you depend on steel or other products that are or could be tariffed, globalization means that alternate supplies should be explored.
If there are few alternatives or capacity is significantly limited, then expect costs to rise even more severely than would be indicated by the tariffs only. In this case, you should aim to lock in margins and generally reduce uncertainty by seeking long-term contracts with suppliers and buyers.
2. Customer responses to price
Customers’ responses to price vary depending on the relative value they ascribe to your products and their ability to source elsewhere. If your product is key, cannot be easily substituted, or switching represents a significant risk, then customers will likely be less price sensitive. For example, U.S. health regulations make switching products difficult and, together with high profit margins, these make medical products and devices less price sensitive even though some components that go into these products may be subject to tariffs. Conversely, if there are readily available substitutes, customer margins are tight, or you sell large volumes that are not critical to their own activities, expect price sensitivity
Certain products such as specialty steel, may also qualify for tariff exemptions so that in such cases, prices would not be impacted. However, the process is highly risky and as of the end of July, there was a backlog of an estimated 16,000 applications. In addition, decisions are notoriously inconsistent. For example, Shell applied for tariff exemptions for high-specification steel pipes from Nippon Steel for deep water oil and gas production. The Commerce Department ruled that 3.5 inch tubing was acceptable, but not 4.5 inch tubing.
While your competitors will also face the same tariff pressures, they may be impacted differently, and their responses may differ depending on their own cost structures, objectives, supply chain options, target markets and customers, and strategies. In addition, you need to look at previous competitor actions to determine which markets or customers are viewed as critical.
Competitors may try to minimize price increases in critical markets while countering the impact on their bottom line by increasing prices more in other markets. You need to understand your own key markets and develop your own pricing strategy based on which markets are critical and prepared to defend given competitors’ objectives and pricing strategies.
This may be especially the case in the dairy industry. Should NAFTA flounder, Canadian dairy producers will face significantly higher tariffs in the U.S. market. In this scenario, Canadian producers will need to target markets for which they provide unique differentiable value that will match prices needed to maintain profitability requirements. Should Canada cede some access to its market, then Canadian producers should manage against price reductions and margin erosion. Locking in distribution channels through deep volume-based price concessions are one approach. Conversely, some specialty dairy producers may accept market share losses in exchange for margin preservation.
4. Implementation: how to increase prices
So, let’s say that you’ve determined that you’ll need to increase some prices. What should you do?
The key is to not make customers feel they’ve been taken advantage-of; something that could rebound against you over the longer-term. Avoid shock. If prices are raised too much at once, anger results, and while customers may stay with you, the relationship becomes soured. They may bolt at the first opportunity.
Some basic principles for successfully implementing price increases include:
a. Time increases carefully to match market developments so that customers can better understand the rationale
b. Work with clients to mitigate the damage; for example, you may agree to a price increase schedule that is perceived as fair to both, given the changed nature of the cost curve
c. Reinforce and focus on the price-value proposition by segment
d. Offer improvements in the product/ service with the price increase
e. Create product/service bundles
f. Above all, ensure that the sales force is closely engaged in preparing and presenting the value-proposition
One final piece of advice, it’s very unlikely that the market will respond exactly the way that you’ve mapped out, so be prepared to regularly monitor the market. Get feedback from your sales team and customers, collect data, and review that information. Expect to make course corrections.
Alain Meloche is the Global Practice Lead, Strategic Pricing for the Internal Consulting Group (ICG), an international consulting firm that provides strategic and operational consulting services. He can be reached at: email@example.com.