Rethink Your Pricing Strategies Amid Economic Uncertainty

Welcome to HBR on strategy, case studies and conversations with the world's top business and management experts hand selected to help you unlock new ways of doing business. Rafi Mohammed, founder of the consulting firm Culture of Profit, says that during a crisis, companies often instinctively slash prices to keep customers or raise prices to capture sudden demand. But he says both of those reactions can be short sighted and easily backfire. In this episode of HBR, IdeaCast Mohamed talks with host Kurt Nickish and offers alternative, more effective pricing strategies for uncertain times. Since their conversation took place in 2020, the crisis you'll hear them referring to is obviously the COVID 19 pandemic. But these lessons apply well beyond that moment to any period of economic instability and full disclosure. Harvard Business Publishing has worked with Culture of Profit. Here's Mohamed.

I think if you don't get your prices correct, it could start the demise of your organization. Pricing is really going to be key during these very challenging times for consumers. And sort of due to uncertainty, a lot of companies aren't giving financial guidance and they're really being conservative. So what that translates into is unless you're a company like Netflix or Peloton, which is enjoying demand, most companies are facing a weakened consumer that's very uncertain about the future and that's a very challenging time. So price is very important.

Yeah.

So most people think about pricing as a two lever strategy, raise or lower prices. Price is far more than sort of a period, a point on the demand curve saying this is the right price. There's a lot of creativity associated with pricing that's really untapped.

And does that hold for a crisis like this one or during a recession? I just wonder if you should approach pricing the same way or differently when you're in a situation like this.

This creativity really should be done in any type of economy. And here's what's really interesting is that in a recession oftentimes people say I want a lower price. But I've been involved with many pricing strategies where my client has been in that situation. And once they offer a low price version, the price point is out there. But customers will ultimately say, gee, I actually think the value of your current price is pretty good, so I'll stay at the current price. One of my favorite strategies is the concept of good, better, best. And a great example is the airline industry. Many airlines have come out with a basic economy type of seating, one which you don't get, advanced seats, you can't upgrade. There's very a lot of penalties associated with that. And what airlines has found is that over 50% of customers that start at the lowest price end up upgrading to a higher price. So it's good to have that price point out and some people will take it. But oftentimes having a good version will highlight the value of your other products, of your better and best products. And while it seems counterintuitive, especially during a recession, sometimes offering a best product is actually very good. And so a good example is the best product is your Rolls Royce product. And while it seems counterintuitive to have a higher price if you can justify the value, the long run value of your product, in this climate, customers are willing to listen why they should pay a higher price if it can be justified by it's better for you in the long run.

So what do you do if you're say a movie theater or traditional retail where you are experiencing a cut in demand, a hit in demand short term right now due to the crisis, but you're also not expecting it to bounce back strongly or even recover to the level it was before for some time.

Clearly in the short run you have to offer a discount. And what I would be focused on is what I call discounting with dignity in a manner that doesn't devalue your product in the long run. And so that's really important because once you set a low price, it's very hard to recover when demand eventually does come back. And so a couple of ways that you can sort of discount with dignity is for instance, require a charitable donation. You'll get a lower price if you donate to a charity. And what you're clearly psychologically communicating to customers is that this is a one off, this is unique, don't expect this for the long term or require bulk purchase. You can get four, you have to buy four movie tickets, but you get a low price. And in the customer's mind, they can justify that price decrease because they're saying, oh, they're giving me a volume discount or changing the terms. You know, you can impose more stringent terms. It could be cash only, you know, know, no delivery, no returns. And what that does is once again reinforce that this is a one off deal. And finally, what I've seen is that is that sometimes clients, businesses will discount price because they want us to show a client that their partner, they're in it with them during this, during the long run. But it's really important to set a metric about when your price is going to go back up. So let's say you're in the financial services industry and you set a Low price. You can say, look, I'm willing to give you a low price, but when your stock price reaches X, then we're going to go back to the, to the higher price. So what I'm trying to outline are ways that you can discount in a manner that doesn't devalue your product in the long run.

Now what if you're say a quick service restaurant where you're taking a hit short term now. Right. Somebody that didn't eat there in April is not going to make up that meal later like that's gone. Not to mention the, you know, lower density possibly in these restaurants or the extra cleaning and expenses that they have or additional people that they have to hire to handle safe service. This is more than demand returning, it's also a new cost scenario that you have to have to consider.

Exactly. And you know, your clients who are coming in, they might be, they don't have as much money in their pocket as they did before the virus hit. And so you have to be cognizant of that and offer them choice and offer them new types of entrees and really understand them and provide a product version that's for price sensitive people. Remember, some of the customers might be very happy to come back and there's no reason to discount their price. And some customers you might get who are trading down from a higher level restaurant and they might be wanting to come into a mid level restaurant and say, well, I want the best because before I was dining out at a higher price place. So that's why the notion of really not discounting and providing your customers price based options is so important.

What if you just look at the scenario and you realize that you have, maybe you're only allowed to operate your restaurant at 50% capacity for some time and you realize it's not even worth it to open unless you can charge more for the people who are coming in. Can you at a surcharge, can you raise the price and also communicate that that's going to be temporary, but just communicate that this is sort of what's needed to keep the lights on at the moment.

Great point. And certainly some restaurants will have to raise prices because it just doesn't make sense for them financially to be in business due to increased cost and reduced table seating. And it's really important in those cases to communicate it. So it's the COVID 19 surcharge. And be very clear with customers, this is why we're doing this. We have to do this. It's not necessarily always about you don't always have to offer a discount. You could offer a minimum, a table minimum. So I'm sorry, instead of charging a higher price, you could offer a table minimum which would get people to spend more than they otherwise would and make that table more profitable than if someone came in and just ordered an entree and water. So there are other ways besides prices.

Now let's talk about something that's kind of fun, which is this idea of revenge buying or revenge spending. That's where businesses have taken a hit short term, but they expect it to bounce back and perhaps even exceed what they had before. Travel and vacations is one of those where people are banking vacation days and that industry has stuff to work through, but is also expecting in some scenarios booking more stuff further, further out where they expect people to like pile on and serve this pent up demand. What do you think through pricing for a scenario where you think you may have higher demand than you had before?

Well, specifically in the travel industry, they've done a great job of telling customers our prices are going to be different all the time. And, and so my favorite hotel in the Caribbean, I'd say during the summer is 1/5 the price of what it is during the winter. And so for most travel related industries, customers are okay and have accepted the notion of dynamic pricing, that pricing is gonna change. So certainly in those industries there's the opportunity to capitalize on this higher demand with higher prices. But however, for other types of industries, yeah, sure there's a pent up demand, but, but if you raise prices, people remember prices. And so yeah, I get that there's higher demand, but you're in it for the long run. And for instance, there's a famous ice cream place very close to me and I'm sure the moment that they reopen there's gonna be lines out the door, socially distanced lines of course, and I'm sure they could raise their prices, but people remember that price and then in a couple months when people think about coming back, that higher price is gonna be in their minds. And so I would sort of restrain myself from, from having higher prices, perhaps offering a best version to capitalize on that demand. But I wouldn't increase prices.

And what about just you said let's not worry about Netflix and Peloton, but what if you are those companies, you have big increases in demand and you expect that to be higher after the crisis than it was before. And we're seeing that in China in probably the most advanced economy to be in the recovery stage. Online game usage and Online video watching is like 10% higher now than it was before the crisis, even though it spiked higher during it. How do you think about it if you're in that enviable position?

Well, if demand and taste has shifted, for instance, I think a lot of people have found that, well, maybe I can work out at home and I don't have to go to the gym then with that increased demand, if it's sustainable, then as the economy recovers, you may want to think about having higher prices or giving people more a la carte options or having the best option to sort of capitalize on that increased demand.

It seems tough though still to set your prices and think through these creative thoughts things at a time of flux, right? You've talked about being careful not discounting too much. You've talked about not raising it too high. And so the default there might be to kind of keep things mostly the same. And how, how do you get the gumption to say, you know, we really need to analyze this and try out a different pricing strategy at a time when it feels like it's, it's easy to be risk averse.

We're coming off of a time of sort of forced reflection as you've in tone. Pricing is something that management struggle with all the time. And a lot of companies are approaching sort of the reopening as a time to reset, sort of reset how they think about their strategy in general. And pricing is certainly one of those tools. But I think more importantly, and I've seen this time and time again recently, is that customers are starting to say to, to businesses, we still want to do business with you. We just don't like the way that you price. Don't like doesn't necessarily mean lower price. It's. We don't like the strategy that you're using. So not only you may have an interest in resetting your pricing strategy, but oftentimes what you're seeing is customers are now starting to demand that you change your pricing strategy.

I'm curious how you recognize when you're getting that feedback or what are the classic things that you hear from customers or you see that, that give you an indication that they don't like your strategy, as you said.

Well, certainly at this time I would do sort of a quick survey of customers to better understand how they're thinking about your pricing strategy and the value that you provide. So let me give you like a wonderful example of a company that did that. Hyundai did this in 2008. During 2008 financial crisis, you know, things were Bad. The stock market was down. There were a lot of layoffs, and Hyundai actually took the time to listen to their customers. And the customers basically came back and said, look, of course price is an issue, but the real issue for us is that we're worried about losing our job. So in 2009, Hyundai rolled out a pricing strategy that really, that sort of an assurance strategy that said if you lose your job, you. You can return your car to us, no questions asked, you don't owe us any money, and we'll call it a day if you lose your job. And here's what's so fascinating about that strategy. They listened to their customers, and in 2009, overall auto sales dropped by 20%. But Hyundai's sales increased by 8%. And they're quoted as saying that in the first nine months of the program, less than 50 cars had been returned. That's an incredible example of a company that listened to its customers and create a pricing strategy to solve what. What their true needs were.

What have you been seeing businesses do, whether they're small or large, where you've thought that's really smart or they should really rethink that?

What is interesting, you know, at grocery stores, I've actually found that their sales pages are getting thinner and they're not having as many big sales as they used to. That's because demand is up significantly. But for companies that are sort of thinking about their pricing strategy, one of the easiest things for them to do is to scrutinize the discounts that they offer. So let me give you an example. McKinsey did a study, and they found that a 1% increase in price, if demand is held constant, would on average increase operating profits by 8.7%. It's not bad. There's a very significant increase in profits due to something very small, 1%. And what I would recommend for companies these days, when you know the reopening, is for them to scrutinize their discounts and ask themselves, do I have to give this discount? And oftentimes, when a company figures out what 1% is to its bottom line, I've seen Salesforce's look shocked because they handing out 5 to 10% discounts very easily without much thought to it. And I'm all for discounting as long as you get a return on your investment. And many times these discounts are unnecessarily given.

How do you know when the time is right to raise prices again?

I think that when you see the economy improving and people becoming more confident about their spending and you're seeing your business approaching in terms of numbers, approaching what it was pre crisis, that's a good trigger. And for a restaurant, it could simply be rejiggering your entrees and taking off some of the cheaper entrees and moving to some of the higher priced entrees. For a retail outlet, it could be the same thing of changing the SKUs that you're offering and or reducing the frequency of the sales that you've been offering.

We're talking about this crisis as a very simplistic. There's this crisis now and then there's the recovery and then back to normal. But it's clear that the recovery could be gradual in a lot of places. It could go back and forth with future waves and shutdowns before a vaccine or, or other therapies are in place. So considering that there may still be a lot of ups and downs and it may not just be a V shaped recovery like a lot of people are hoping, is there anything you can do pricing wise to ride out those fluctuations?

I think the next year or two is one of caution for businesses and it's an area where I wouldn't necessarily rock the boat on pricing and so come out with your new strategy and maintain it. And I think we're going to have to ride out the recovery and then at that point, I think there's an opportunity to reconsider your pricing strategy as well as your prices.

On this notion of a reset, what's the biggest misconception that businesses might have about that?

I think the biggest misconception of pricing is the notion of cost. Plus, whatever our costs are, we're going to add onto it. The key to better pricing is one, to consider what the customer's next best alternatives are. But two, just as importantly, listen to your customers and see what they're saying about your pricing. And that's a component that most companies don't do. And I always think about street vendors in the middle of Central Park. The minute that it looks like it's going to rain, these street vendors double the price of their umbrellas. And this simple doubling of price illustrates three key points about pricing. First, pricing has very little to do with your cost. You know, your costs haven't increased, but your price has gone up. Second, price is all about your customer's next best alternative. So if I'm in the middle of Central park, it's about to rain, you know, my only option is to, you know, run 10 blocks to CVS and hope I can get an umbrella before it rains. And the third and most important point is the key to pricing is to think like your customers and your customers are in the middle of Central Park. They're willing to pay a premium over the next best alternative, and it's understanding what makes your product or service so unique and and then setting a price to capture the value of your uniqueness.

Rafi thanks for coming on the show to talk about this, Kurt.

I appreciate it. It's been fun.

That was pricing strategy consultant Rafi Mohammed in conversation with Kurt nickish on HBR IdeaCast. We'll be back next Wednesday with another hit handpicked conversation about business strategy from Harvard Business Review. If you found this episode helpful, share it with your friends and colleagues and follow our show on Apple Podcasts, Spotify or wherever you get your podcasts. While you're there, be sure to leave us a review. And when you're ready for more podcasts, articles, case studies, books and videos with the world's top business and management experts, you'll find it all at@hbr.org this episode was produced by Mary Dew and me, Hannah Bates. Kurt Nickish is our editor. Special thanks to Adam Buchholz, Ian Fox, Maureen Hoch, Erica Chuxler, Ramsey Kabaz, Nicole Smith, Anne Bartholomew and you, our listener. See you next.

Sam.