Protecting margins in the next few months will prove extremely difficult which is why consumer perception of value is key
HARD-PRESSED brand manager, come on down! And welcome to tonight's fun-packed episode of The Price is Right. You will be joined on stage by your fellow contestants: anxious investor, frazzled supplier, ruthless deep-discounter, ball-breaking grocer and credit-crunched customer. Your boss will be watching at home. This could be one hell of a show!
Or perhaps not. At times like these, with no one knowing quite what is about to happen to consumer demand, getting the price right is harder than ever.
What will the market tolerate? And how can you set prices with any confidence when your own costs may be about to soar, or tumble?
Nine years ago, the Economistreported on the dramatic fall in the price of oil, and the arrival of the $10 barrel. But worse was to come, it said: "$10 might actually be too optimistic. We may be heading for $5." Now a barrel of oil would cost you around $135.
In Economics 101, students learn about "fair market value", the price at which an asset or service passes from a willing seller to a willing buyer.
This definition is based on the principle that both the buyer and the seller are rational and have good data on the deal they are doing.
But it may take more than mere rational analysis to explain today's price volatility. George Soros, the hedge fund billionaire, argues in the new paradigm for financial markets that many market prices now fluctuate in "initially self-reinforcing but eventually self-defeating boom-bust processes, or bubbles".
In this frenzy of bubbles, prices head towards a "far from equilibrium position", in defiance of pretty much everything you were ever taught about the iron laws of supply and demand.
You can see businesses at the moment struggling to keep up with wobbly prices and even wobblier demand. Last weekend, Marks and Spencer offered UK customers an eye-catching meal deal - all sorts of ready-made delights, with pudding and a bottle of wine thrown in, for £10 - roughly speaking a half-price basket of goods.
Other leading UK supermarkets have been making similarly margin-shattering reductions, way beyond the traditional "loss-leader" gambit.
Bigger ticket items are coming under equally intense pressure. The US carmaker Ford has been forced to revise its planned return to profitability in North America in 2009 in the face of steeply rising commodity prices and falling sales. It is not so much a case of "unsafe at any speed" as "unsellable at any price". Try making profits in a market like that.
And then, last year, there was the embarrassing saga of the rapidly repriced Apple iPhone.
Launched in July with an asking price of $599 (€385), by September the company was forced to slash that by $200, offering a $100 voucher to disgruntled early adopters who had paid the full amount. The new, twice as powerful 16GB model is priced at $499 - an admission of how far off the original price tag had been.
Customers are not stupid. They can spot a good deal when they see one. And they are prepared to wait until the deal on offer represents good value.
This applies to big, expensive items like cars, but also to much more modest purchases too. After much public protest, competition officials in Belgium were recently instructed to investigate the outrage of the €2 portion of chips.
How do you prevent "value erosion" and protect your margins?
You need creativity on pricing. Consider the printer ink cartridge. Research by the consultancy AT Kearney shows that, measured in cost per millilitre, the ink in that cartridge is almost three times as expensive as Chanel No 5.
I am not, incidentally, suggesting that this argument will prove very persuasive should any cost-conscious husbands present their spouses with supplies for the home office as a birthday present, instead of perfume.
Coffee is the other classic example of a market where innovative pricing has helped businesses build healthy profit margins. Upmarket coffee shops and coffee capsule machines have shown how you can make money without pricing customers away. It is a question of perceived value.
"It is certainly not the case that consumers don't have any money or that they don't want to spend," AT Kearney says in a recent paper. "The product offered just has to be convincing."
Special offers and discounts may be unavoidable at a time like this. Showing sensitivity to the pressure your customers are under may prove beneficial.
But price wars - the mutually assured destruction option - are best avoided, even if you have deep pockets. They merely "teach your customers to buy on price", as Richard Balaban of consultancy Oliver Wyman puts it.
Prices can go up as well as down. I know of one premium product that has hitched its asking price by 50 per cent in the past year, with no negative impact on sales - the Financial Times, where I work.
But for most businesses protecting margins in the next few months is going to prove extremely difficult. Cynics, Oscar Wilde once said, know "the price of everything but the value of nothing". You know things are tough when the cynics don't know the price either.
- (Financial Times service)
Lucy Kellaway is away.
