Cost inflation and Pricing orientation

It’s back to school time. And for many, it’s the time to prepare next year’s budget.

Back-to-school pricing resolutions

Do not rise the price in case of inflation

This period is often rich in reflection, discussion and irritation.

Variable costs are rising by 2% and fixed costs by 1%? So let’s raise prices by 4% to keep our profitability level intact!

Pushing up prices is the first and most obvious lever. The marketing department will then try to justify the price increase, the sales department will try to convince partners that the product has improved and the operational staff will try to cushion the impact on customers when the product is consumed.

But if raising prices is all it takes to create this dynamic, why wouldn’t we have done it before to generate a higher margin?

Because this dynamic isn’t virtuous when it is driven by a simple inflation constraint.

Fuel surcharges abolished in the airline sector

The airline industry was one of the first to question the relevance of systematically adjusting prices to costs. Until 2008, airlines added a fuel surcharge to the final price. This tax appeared alongside airport taxes and became illegible in the eyes of customers. When the airline was not covered against fluctuations in the price of oil, the surcharge varied regularly according to the price of black gold on the market. There was a great deal of misunderstanding among customers: would they one day also have to pay a « staff » surcharge if pilots’ salaries went up?

The explosion of low-cost airlines and their aggressive strategy to capture market share destabilised prices across Europe. At that point, Revenue Management played a decisive role by analysing the market, diagnosing commercial performance by time slot, gauging the quality of the product in relation to its competitors (flight departure, frequency, quality of service, options included, etc.) and deconstructing the pricing structure in order to rebuild it on the basis of an innovative and calm sales, marketing and operational action plan.

Even though fuel is the first or second cost item for airlines, boosting or wiping out margins over the years, the surcharge has gradually been removed from the customer’s bill. By avoiding selling at a loss, prices have fallen on many airlines.

During the budget phase, the Revenue Management Pricing teams play a vital role in guiding the company’s strategy. They have to analyse the performance of the product and its expected evolution in relation to the competition and market expectations. After the fact, they identify the variables that explain the over- or under-performance. This intrinsic analysis helps to clarify the pricing positioning, which will very rarely be consistently upward.  It will also enable Revenue Management levers to be fine-tuned, marketing to be focused on a flagship customer segment and Sales to be positioned on a high-performance distribution channel and customer segment.

This global approach alone can set in motion a virtuous dynamic.

N&C has supported a number of players in a wide range of industries in this approach.

Keywords: Pricing, variable cost, Revenue Management, airline, Marketing