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Supply chain

Agile pricing will help firms profit from supply chain constraints 

Published 14 April 2022 in Supply chain • 5 min read

An inability to change prices on a more frequent cadence is proving to be the source of a huge missed opportunity when supply is limited, particularly for automakers.  

 

Supply chain constraints are driving companies across sectors to push through steep price increases as demand exceeds supply, contributing to soaring inflation. Yet even businesses that have boosted their earnings in the past year are leaving money on the table, with a poor pricing strategy proving to be the source of missed opportunity.   

Smart organizations are developing a better understanding of where they are placed in the market, and how quickly they can change prices in response to supply and demand dynamics. The automotive industry provides a real-world example of this strategy and the underlying problem in pricing strategies.  

Despite sales of vehicles decreasing due to the lack of microchips, global carmakers banked much higher annual profits last year, as they implemented substantial price hikes and prioritized the production of more expensive, higher-end models to cope with the semiconductor crisis.  

The shortage of semiconductors, which are used in everything from infotainment to driver assistance systems, forced companies to cut vehicle production and shut factories around the world. The shortage is caused by a backlog of orders due to the COVID-19 pandemic as chip makers have given priority to more lucrative suppliers such as technology companies.  

Carmakers have, however, coped quite well with these challenges, because they raised prices and gave priority to manufacturing higher-margin models to keep profits up, instead of chasing volume.  

BMW
Sales are down but profits are up as car manufacturers focus on selling high-end models.

 

General Motors, Ford and Volkswagen sold 20% fewer cars in 2021 than in 2019, yet they posted profits that were 48% higher, according to an IMD analysis. In December 2021, the average price of a new car set a fresh record and topped $47,000 in the US, up 14% on 2020, according to automotive research company Kelley Blue Book.  

But carmakers may have left billions of dollars on the table, with a poor pricing strategy largely to blame. There are many other sectors from machinery to fast-moving consumer goods where supply chain executives believe that their companies have missed out on substantial profits because of their inability to change prices according to supply constraints. 

The clearest indication is that car dealers are charging excessive fees, above the recommended retail price set by manufacturers. In January 2022, customers paid above the sticker price in 82% of new vehicle purchases, compared with about 3% in January 2021 and 0.3% in 2020, according to Edmunds, a car shopping analyst.  

On average, customers paid $728 above the asking price in January 2022. This means dealers are reaping more of the spoils from the car shortage, leaving automakers out of pocket. To be sure, Ford and GM have both publicly called for their dealers to stop charging excessive mark-ups. 

Rethink pricing processes 

But they should look internally and rethink their pricing processes, particularly at a time of supply disruption and rampant inflation. Our first suggestion is to focus on agility in pricing, which means having the technical ability to change prices on a more frequent cadence based on real-time, granular detail that can constantly inform an evolving pricing strategy.  

Traditionally, automakers have priced vehicles on an annual basis. This is because they have used longer-term, more rigid contracts with suppliers that cannot be adjusted quickly to changes in demand. Smart organizations will be rethinking their supplier relationships.  

Airplane ticketsAirlines can adjust their prices on the fly because they have direct access to their customers.

Our second suggestion is prioritizing shorter-term contracts in order to build adequate flexibility into the cost base and therefore tweak prices in response to what is happening in the market, which is rapidly changing.  

In addition, automakers have traditionally overproduced vehicles. They will need to shift away from holding larger inventories, which leads to vehicles that end up stockpiled on dealer lots, forcing through discounts to make a sale. Instead, automakers should be building to customer orders and cutting inventories to maintain pricing power that has not been seen in decades in this sector.  

The key to doing that successfully is getting closer to the customer. Yet pricing decisions seldom receive input from those at the coalface of customer acquisition, such as chief marketing officers, nor those who have the greatest visibility over supply side dynamics: supply chain executives.  

Understand customer demand 

Achieving greater agility in pricing means integrating these seemingly disparate functions as part of the same decision process on pricing — our third suggestion. Having a granular understanding of consumer demand means companies can see if their price proposition is proportionate to the market on an ongoing basis. 

For example, ticket prices for airlines can fluctuate by hundreds of dollars from day to day, based on the forecast demand for a destination. The reason airlines can adjust their prices on the fly, as it were, is because they have direct access to their customers. In contrast, carmakers rely on dealers to sell and service their vehicles. This means they lack access to real-time data on what customers are willing to pay. 

Tesla and other upstart electric car companies such as Rivian and Lucid are the exception. Unlike legacy automakers, Tesla’s business model is based on direct sales to consumers through company-owned showrooms and online channels, instead of franchised dealerships. Because it owns the sales channel, Tesla has an advantage in the speed of both its product development and its pricing strategy.    

A more fluid pricing process means Tesla has been able to insulate itself against the significant inflationary pressures that have been exacerbated by war in Ukraine, protecting its already high profit margins. In March 2022, Tesla raised prices across its entire US product range twice in a single week to cope with surging costs for raw materials such as nickel and lithium that power electric vehicle batteries.  

A more fluid pricing process means Tesla has been able to insulate itself against the significant inflationary pressures that have been exacerbated by war in Ukraine

The lesson for organizations is that they need to create agile pricing processes involving various parts of the organization because the external environment is much more volatile than before. To do that successfully means tearing down traditional silos between departments in organizations, with sales, marketing, finance and supply chain functions acting as a block on pricing agility. Chief executives must unite various units together to achieve better price planning, ensuring that divisional heads build cross-functional expertise.  

In markets with much higher volatility of supply and demand than ever before, if companies do not price in a very agile way, taking into account sales and production, they could be missing out on substantial profits as supply continues to be limited and costs continue to climb.   

Authors

Supply chain

Carlos Cordon

Professor of Strategy and Supply Chain Management

Carlos Cordon is a Professor of Strategy and Supply Chain Management. Professor Cordon’s areas of interest are digital value chains, supply and demand chain management, digital lean, and process management.

Stefan Michel

Stefan Michel

Professor of Marketing and Strategy, IMD

Professor Michel’s major research interests are in customer-focused marketing strategy, service innovation, and pricing. At IMD, he is the Dean of the Executive MBA program and the faculty representative at the IMD foundation board. He teaches in the Executive MBA, Strategic Marketing Program, the Foundation for Business Leadership Program, the MBA program, the Orchestrating Winning Performance program as well as in many partnership programs for world-leading companies.

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