By KARL-HEINZ SEBASTIAN
He feels like he’s in the dock, facing a sentence from the judge. The wooden bench he’s sitting on is cold and hard. Behind the heavy doors, the directors are holding their board meeting. They’re already behind schedule; he’s been waiting for 45 minutes now. Soon he’ll be called in to give his sales report, and to defend the damning accusations: rising raw material costs not duly passed on to customers, and losses of millions of euros. If they find him guilty, his head will roll.
He’s had sleepless nights wondering how it could have come to this.
The warning cries had been getting louder for months. Raw material costs had spiraled upward, and the purchasing department had announced bad news so often that people had stopped taking it seriously. Purchasers were accepting price increases more and more frequently to keep deliveries moving and not to endanger the production process. Key account managers were told in no uncertain terms to stop long-term price-fixing. The controlling department forecast a profit slump of up to 50 percent if the rising raw material costs were not passed on immediately and proportionately to customers. It was an absolute nightmare.
Three attempts had been made to raise prices in the last 12 months. His sales team couldn’t cope, and the sales figures dropped even further after every price increase. Without convincing sales arguments, internal quality problems became another tricky issue in every negotiation. Customers didn’t understand why prices were going up yet again, sales talks failed, and sellers tried to sidestep the price increases by offering credit and refunds under the table. As a result, the rising raw material costs were not passed on to customers. The competitors were at fault for their lack of solidarity. The customers were at fault for not wanting or being able to put up their prices. But the greatest blame, he thought to himself, went to his own board of managers. In a sudden show of muscle, they raised prices by up to 20 percent, but would not tolerate a single lost customer or even the smallest drop in volume. Confidence in the market began to ebb away. The main competitors all struggled with the same problems, but that doesn’t help him now.
The door opens and he is called in. But before he can start speaking, a surprise guest arrives. Without telling him, the board has invited the new guy from Controlling to the meeting. Ah, so that’s the new pricing manager, he thinks. But what can he possibly know about our situation? And this guy wants to help us? No chance! But we might as well see what he has to say.
“We’re caught in a trap, it’s called the prisoner’s dilemma,” says the new pricing manager. “It’ll be almost impossible to escape from it on our own.” That sounds like a death sentence! “You feel threatened by prices,” he tells the board. “You think they’re difficult to control and commanded by external factors.” But our price development IS threatening, and we CAN’T control it, he thinks. “Stop looking at prices as your enemy. They should be your friends!” What?
“Thirty million euros,” continues the new guy. “That’s how much profits are predicted to fall if we don’t immediately pass on rising costs to our customers, or if we make too many exceptions.” His stomach ties itself into a knot. That’s exactly what’s been happening in the last few weeks. Should he be comforted by the fact that every supplier is facing the same problems? It doesn’t matter whether they’re backward integrated or have tried to cap raw material costs by fixing their prices; everyone’s in the same boat. “If things stay as they are, it’ll just be a matter of time before the whole industry is standing at the edge of the abyss.” That’s the first nightmare over with. But here comes the second: “A supplier raises its prices, but its competitors don’t follow. They gain volume, so it looks like they’re doing better than before — but they’re still losing profits. Now the supplier that increased its prices is in a lose-lose situation: fewer customers, a drop in volume, and a fatal loss of profits.” So what happens next? The struggling supplier gives in (trying to make the best of a bad job, he thinks to himself) and lowers its prices (revenge is sweet), but then the others launch a counterattack (more revenge is even sweeter). After a brief but fierce price war, everyone is back to the same sales volume as before, but the overall price level has fallen. The outcome? Lower profits for everybody! “It’s a worst-case scenario, but it’s highly likely,” warns the new pricing expert. I’m starting to like this guy, he thinks, suppressing a smile. Peering over the abyss with everyone else sounds a lot better than my own head rolling down the precipice all by itself. But the managers at the meeting look far from relieved. The silence is deafening. He feels a sudden shiver.
The pricing manager continues undeterred. Before he launches into the next scenario, he reveals its outcome: higher margins and profits. Wait a second, wasn’t he just predicting our downfall? And now he wants to save us from our hopeless situation? Still preoccupied with saving his own head, for the next few minutes he follows the conversation only sporadically. Price leadership, preparing the market, price communication, plan B… But when profit growth is mentioned, he is jolted back to full attention. Systematic market preparation clearly reveals the necessity of price increases. When customers are enabled to raise their own prices, market acceptance improves. Prices climb as a result — perhaps not immediately, and perhaps underproportionately. Volume will still fall slightly, but profits will remain stable, and maybe even rise in certain market regions and product segments. Profit growth, he thinks, drifting back into his daydreams. So it really is possible. Price increases for the competitors’ key accounts, peaceful competition, negotiation control room… it’s too much to take in all at once, but nobody is paying him any attention now. “Yes, this company can boost its profits by up to 15 million euros,” concludes the pricing manager. He sits down to the stunned silence of the management board.
“BRRRRRRRRRRRing!” The sudden ringing of his alarm clock rips him out of his sleep. So it wasn’t another sleepless night after all. But what was the dream trying to tell him? Might there really be a way out of the situation? Could the nightmare have a happy ending?
Dr. Karl-Heinz Sebastian is a senior partner at Simon-Kucher & Partners, Strategy & Marketing Consultants in Cologne/Germany. He heads the Construction and Commodities Competence Center and specializes in optimizing price strategies, processes and systems.