Pricing During a Recession: Some Lessons Learned from the 2008-2009 Recession – Part 3

(from Issues for Growth Vol.18, No.12)

Recently, we held a meeting with the CEOs and/or owners of two dozen of our clients across a variety of industries. As you might expect, some are experiencing very tough times, some are doing remarkably well, and most are holding their own. To a person, every one of them has a clear understanding of the tactics for the balance of 2009.

A number of them have downsized, management and employees have taken pay cuts and/or reduced work schedules, product lines have been streamlined,

As we discussed the measures and actions taken, it became clear to me that we collectively have learned or reaffirmed some basic management lessons during the past year that we would all do well to remember once the economic fortunes turn brighter. We had a lot of fun spending a couple of hours discussing lessons learned. Some of these will be presented in more comprehensive fashion in the next few Issues for Growth. - DPM

One big issue is what to do with pricing.

Pricing during a recession is a very controversial subject. If customers are not buying, the tendency is to reduce prices across the board to get customers to buy. Does it work? Research tells us that generally it does not increase volume. If folks are nervous about spending, they will still be reluctant to buy even with a discount. What happens is that you wind up selling to folks who would buy anyway, but at lower prices and lower margins. Companies that discount sometimes cause a cycle of expectations that takes years to correct.

It is far better during a recession to preserve pricing to maximize profitability and cash flow at lower volume levels.

Some Pricing Thoughts

* Discounting prices across the board does not increase volume; it only lowers profitability
* It may take as long as six years to recover pricing stability after broad-based discounting
* Discounting may devalue your product or service in the customer’s eyes
* More effective than across the board discounting is to price to change behavior.
- Buy one, get one at 25% off increases volume.
- Offer the upscale model and offer a discount off a companion product.
- Offer a slower selling model and offer a free component (e.g. buy a PC and get a free DVD or free software included)

What are your pricing strategies during the downturn? What is working? What is not working? Let us know your thoughts? Share your experiences.

At the End of Every Recession There is a Decision Point

(from Issues for Growth, Vol.18, No. 11)

During a recession every company and every decision maker will cut costs and therefore buy fewer services or products. There will be no decisions on new directions for the company or implementing new solutions. During downturns, companies tend to stay with existing proven solutions and services as there is little or no room for experimentation.

The Dark Tunnel
As the world keeps wandering through the dark tunnel of the downturn, business will be spending less and less on products, services or solutions. The journey through the tunnel is long, cold and dark. However, one day the end of the tunnel will be there. Not all businesses or markets will emerge at the same time from their tunnel, but all will eventually get out as their business starts growing and expanding again.

Recessions bring the adoption of new solutions
At that moment, decisions on products, solutions, and services will be made rapidly as new opportunities with new business are present and lie ahead for companies. These decisions concern the services and solutions to run or operate their business. The more efficient and more beneficial these services and solutions the more likely to find adoption.

This is the dangerous decision point since it is a point of inflection. At the end of the tunnel people and companies will decide how to proceed with their business.

Some of the previously used solutions and products will be reordered, whereas other solutions and products will be compared with new offerings/ new models /new approaches that are now on the market. Since the market constraints and economies of scale have changed during the recession, the outcome from this comparison can result in new direction.
All recessions have led to the adoption of new solutions. In some cases these new solutions may have been existed for a while (even before the recession), but couldn’t find a market that would accept and implement the new solution in large quantities.

Change at the end of a recession – What happens to your offerings?
Your current offerings can continue to sell still relatively well into your market during this recession. However, once your customers’ business begins to pick up again, it might just be that they not choose your product or solution. They may choose a different solution. They may even decide on a radical change that is outside the normal pool of solutions.
Thus even if your current business is not doing to badly during this recession, there is no guarantee that such success will continue once the recession is over. Change can happen rather fast.

From companies with successful solutions to laggards and from challengers to leaders
Although we don’t know how long the journey through the recession tunnel will be, change will be upon us quickly once this downturn comes to an end. Successful products can become laggards overnight and the previous challengers can emerge and become leaders. Change can be driven by technology, social preferences, new economics of scale, new business models, or other innovation.

Will your solutions, products or services rise to become the leaders or will they fall behind and become the laggards?
How well is your company prepared to respond in 2010? Are you taking control of the things that you can? Are your actions strengthening your company - or weakening it? Are you building flexibility into your plans? Have you changed your approach to planning?

Is China On the Road to Recovery?

(One of our partners, Fiducia Management Consultants, recently sent its mid-year review on China, “Is China On the Road to Recovery”. I thought you might be interested in seeing it.-DPM)

Recent indicators show that the Chinese economy may be on its way to recovery though signs remain mixed. Given the size and diversification of domestic markets, we believe that Foreign-Invested Enterprises (FIEs) should pursue opportunities arising from pockets of growth.


SUMMARY

􀂃 The Chinese economy shows signs of recovery …

􀂃 … and signs of worsening

􀂃 Stimulus package re-allocated to drive sustainable growth …

􀂃 … but has little impact for most companies

􀂃 Tight credit for non-SOEs will continue throughout 2009

􀂃 FIEs are comparatively disadvantaged in face of “re-nationalisation”

MACROECONOMIC DEVELOPMENT
As a result of the government’s massive stimulus package (see our May Update), industrial production and retail sales in May rose 9% and 15% respectively from the same month last year. The Purchasing Manager Index (PMI) has been above 50, which represents a month-on-month expansion of manufacturing activities, for the third consecutive month since March.
However, it is debatable whether China’s underlying growth is sustainable. For instance, the export market continues to tumble (declining 26% year-on-year for the first five months), and the problem of over-production remains unsolved in pillar industries such as basic chemicals and steel. In addition, electricity consumption of manufacturing activities hovers at low levels. Consumer prices are also down for the fourth consecutive month. Both factors indicate that China is facing deflationary pressure.

STIMULUS PACKAGE REVISITED
Faced by these new challenges, the Chinese government has re-allocated its RMB 4 trillion investments to drive sustainable growth. While more focus will be put on social welfare (from 1% to 4% share), civil projects (from 7% to 10%), technology advancement and industry restructuring (from 4% to 9%), the government has adjusted the spending on infrastructure (from 45% to 38%) and sustainable environment (from 9% to 5%) downwards. This confirms that on top of increasing fixed asset investment, China has realised it must to keep more wheels in domestic economy turning. To date, the central government has spent a quarter of the RMB 1.2 trillion it committed to the stimulus package.

CHALLENGES
Limited access to subsidies and tenders
Since the largest part of the stimulus package will flow to infrastructure, direct beneficiaries are limited to construction materials and related services providers. Moreover, according to Fiducia interviews with companies and associations in the construction industry, bidding for such projects normally go through public tenders, in which competition among SOEs (State-Owned Enterprises), POEs (Privately-Owned Enterprises), and FIEs is intense. The government subsidy programmes which aim to boost domestic consumption on products such as automotives and home appliances usually favour households in the rural areas and apply to a selective range of low-price products only. Therefore, companies who qualify for the subsidies are limited.

Credit Tightens
Tight credit will continue for the rest of the year after the amount of new RMB loans hit a record high in the first quarter. The credit extension pace has slowed down since April due to the increasing risks which have raised central government concerns. According to interviewees, POEs will be in a more difficult situation as banks’ lending policy usually tilts towards SOEs. Payment terms renegotiation is popular along the value chain in most industries. Credit pressure and cash flow management are still on companies’ top agenda.

Change in economic landscape
Against the background of SOEs receiving more financial support than POEs, the concept of “re-nationalisation” has arisen. This refers to SOEs using their relative financial strength and political support to crowd out or take over POEs, for example in the domestic airline or steel industries. SOEs hold this important role in order to avoid mass unemployment connected with much-needed market consolidation. These national champions are further supported to grow stronger to become internationally competitive.

Instead of seeking advantage from these developments, most FIEs are constrained in China due to their headquarters’ negative performance.


Industry Focus

Automotive

Growth Drivers
􀂃 Provision of cash rebates and tax cut for rural auto purchase (extending to urban areas)

􀂃 Removal of fuel tax and lower petrol prices

FIEs Opportunities
􀂃 Supply or co-develop parts and components for Chinese auto makers and JVs, especially of new energy vehicles

Chemicals

Growth Drivers
􀂃 Recovering domestic demand from downstream industries

􀂃 “Green” export barrier (e.g. REACH, CLP) pushes industry upgrade

FIEs Opportunities
􀂃 Target specialty areas and produce for domestic demand (e.g. construction chemicals)

􀂃 Leverage international best practice

Clean-tech

Growth Drivers
􀂃 Allocation of RMB 26 billion to environmental projects in 2009-2010

􀂃 Improved transparency in public tendering process of environmental projects

FIEs Opportunities
􀂃 Participate in demonstration projects (e.g. pollution treatment)

􀂃 Partner with local companies for government support

Construction Materials

Growth Drivers
􀂃 Allocation of over RMB 150 billion to infrastructures and RMB 38 billion on construction of affordable housing in 2009-2010

􀂃 Sustained demand for commercial property in 2nd and 3rd tier cities

FIEs Opportunities
􀂃 Target on value-added construction materials (e.g. lighting)

􀂃 Develop energy efficient and durable products to meet domestic demand

Skate to Where the Puck Will Be

(from Issues for Growth Vol.18, No. 10)

“ I don’t skate to where the puck is. I skate to where the puck will be.” These words of The Great One, Wayne Gretzky, may not only apply to hockey, but also may be very applicable to business planning for the next few years.

Last week an article in the Wall Street Journal indicated that many are predicting a 10-year secular bear market with the possibility of several selective bull rallies during the decade. If that proves to be reflective not only of the slow-growth economic market but also of market opportunities in general, it will mean that there will be no rising tide that will float all companies and all industries such as we had for the last decade or so.

Is it doom and gloom?

Not at all. The opportunities likely will be in niches. But, deciding on the direction, timing, and the proper niches becomes more critical – and more challenging.

What is your company doing to identify the niche opportunities? Since predicting which areas will explode with 100% certainty is NOT possible, what is your strategy? The chart that follows, illustrates some different approaches that companies take:

1. Betting on the one strategy that would be most favorable (Best Outcome) to your company and hoping that happens. Placing your bet on a future that would be very favorable to your company and hoping it happens. High risk/Low probability of success/Low cost

2. Handicapping the one strategy you think is most likely to occur (Most Probable)based on the past or hunch about the future/ High risk/Low Probability of success/ Low cost

3. Betting on a direction and working to make it more likely to occur (Influence Outcome)

4. Betting on all of the possibilities (Hedge). This is VERY expensive and only the wealthiest of companies could entertain this approach/ High cost/Low risk/High probability of success

5. Deciding on a few possible directions and moving moderately in each direction until the future begins to play out and you then move aggressively in that direction (Preserve Flexibility) Moderate Risk/Moderate Cost/ High probability of success


While they may not always want to admit it, most companies, if they have an approach at all, choose #2, betting on the direction or niche that they believe is most likely based on past experiences or a hunch about the future. The issue with this approach is that most dramatic future growth niches are not necessarily very predictable from the past experience a company has. Disruptive changes often come from outside the industry. For example, The major innovations in the music industry (iPod and iTunes) and cellphones (iPhone) came from a computer-maker (Apple); the major changes in the steel industry (Mini Mills) came from outsiders; the major changes to radios (transistor radios) were introduced by newcomer Sony.

Some rare companies are lucky because they bet correctly. Others, however, have carefully calculated plans. What many may not know is that Microsoft’s bold deal with IBM in the 1980’s for the DOS system – a deal that catapulted Microsoft - was not a “bet the farm” on the “best outcome” or “most probable” strategy. Rather it was one of several strategies that Microsoft was advancing to preserve its flexibility in an uncertain world. Once the direction became clear, Microsoft abandoned the other strategies and put its entire focus behind DOS and IBM.

The environment in 2010 -11 is no less uncertain. The winning companies will be those that innovate, find the new niches and approaches, and carefully position themselves.

What approaches are you using to be able to skate where the puck will be?

How well is your organization prepared to respond in 2010? The market may still be uncertain. While your actions may still be defensive, are they strengthening your company? Are your plans tentative? Are you building flexibility into your plans? Have you changed your approach to planning? Are you prepared to take advantage of the new opportunities and new niches?