Defensive Pricing for the Pandemic
We are in a punishing economic crisis, and it promises to get worse from here. However, there is one thing that is true about any collapse: Inevitably, things recover. Early indications from China show a fast, “v-shaped” return to growth (fig 1). While our recovery may be slower to arrive, the question is not “if” but “when.”
Fig 1: Economic indicators suggest V-shaped recovery for China: Purchasing Manufacturer’s Index , or PMI (left), a forecast of industrial activity; and equity ROI measured as shareholder returns (right.) Note that as of this writing, China’s exports remain soft, and deflation is a distinct possibility, calling into question whether its recovery is durable.
That’s why smart managers will resist the temptation to slash prices. As explained below, a drastic price cut is ineffective in a crisis. However, it is certain to impair your ability to thrive when growth returns.
But if not lowering prices, then what? We offer the following eight-step plan for revenue strategy, built on findings from four prior crises, including the 2000 and 2008 crashes.
- Start with a self-diagnosis
- Identify which customers (and prospects) require concessions
- Find additional “dimensions” for negotiations
- Re-align your price structure
- Label your economic concessions, so you have an “off” switch
- Make it a two-way street: use concessions to motivate behavior that benefits you
- Structure a graceful downgrade motion
- Analyze incumbents for points of weakness
Stay tuned for our Part II on defensive sales.
1. START WITH A SELF-DIAGNOSIS
Most of us have no experience steering a company through major global crisis. The first thing to do is to assess how business conditions have changed. Based on our survey of hundreds of companies in crisis, we have identified the following three conditions:
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DEMAND DISRUPTION:
You’re paying for ads, but no one is coming. Sales leads have fallen to a trickle. Gold customers become silver customers, silver customers become bronze. Long-term subscribers want to cancel.
- Special Condition: Are you seeing a sharp increase in new customers, particularly on your entry-level package? You may be primed to steal share from incumbents (below), but keep a close eye on retention.
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MARKET SHOCK:
Competitors are offering “panic discounts.” You’re having difficulty collecting on payments owed. Supply may be disrupted, or it may be difficult to fulfill.
- Special Condition: If your market is characterized by long-term contracts, you may not see a market shock. However, if risk sensitivity is an issue, you will want to focus on demand generation.
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RISK SENSITIVITY RUNS WILD:
The classic profile here is reluctance to commit to investments in the face of uncertainty, much longer sales cycles, and cancellation of deals that seemed certain to go through. When a deal is “delayed,” it likely is not coming back.
- Special Condition: In some cases, you may see an increase in customers’ risk appetite, if a higher-risk option helps them to preserve cash.
Once you have decided which “symptoms” your business is showing, evaluate the current stage of the crisis. The following chart is a good guide to customer sentiment in each phase. Identifying the phase in which your customers believe themselves to be is the single most important factor for planning your course of action.
Many will focus on purely on the “collapse” and “bottom” phases – and stay in that mentality until it’s too late. This avoids short term pain, often at a high cost, but misses the chance to capture long-term gains. Lack of appropriate planning for the “recovery” phase will cap your growth when growth returns. A rebounding economy is not a tide that lifts all boats. It favors the prepared – so take the necessary steps to rise with it.
2. IDENTIFY WHICH CUSTOMERS (AND PROSPECTS) REQUIRE CONCESSIONS
At a moment like this one, concessions have a real cost. The most successful companies preserve their “dry powder”, delivering discounts, rebates, and other concessions only where they will do the most good. This stars with determining which of your customers, and prospects, are most worth your investment of money and resources.
Reducing prices across the board is certain to hurt your margins, but far from certainty to actually help your business. Instead, concentrate on:
- Keeping gross prices stable, using all other available measures first
- Avoiding price wars
- Targeting selective discounts and rebates to the right customers and prospects
Our studies have shown that the volume-to-price relationship (elasticity) is fundamentally altered during a crisis. You just do not get the same volume reward for a price cut; therefore, price reductions lead to lower volume increases compared to normal economic conditions. On top of the lack of ROI, price concessions can irrevocably damage your brand.
For example, you may decrease price by 1%, expecting a 1% increase in sales volume. The decrease in price affects your bottom line more heavily than the increase in sales volume boosts topline growth. To justify the price reduction, you would have to see a significant increase in sales. But why is it rarely justified? Because discounts don’t address the primary motivator for order modification: A lack of demand. When economic conditions are strained, price reductions lead to lower volume increases than in normal economic conditions.
Instead of spreading a price cut across your entire business, invest your discount dollars in the right set of customers and prospects:
Focus on the customers and prospects that are most valuable to you. This is where you need to double down on key accounts in order to protect revenue: as a rule of thumb, selectively apply discounts as appropriate among your customers that contribute 70% to revenue. In addition to the rule of thumb, consider the following when defining “high value:”
- Profitability
- Tenure
- Potential business
- Strategic importance
- Solvency
Finally, apply the following two factors to your framework:
(a) Some customers cannot be saved, since their business will fail. Therefore, be careful when extending valuable discounts to bad credit risks;
(b) Not all customers need a concession, since some businesses will be virtually untouched by the crisis. Therefore, be judicious in how you grant discounts, and ensure you have the right filtering in place. This is particularly important with thinking through sales comp: Do not reward your agents for “saving” customers that were never in distress.
3. FIND ADDITIONAL “DIMENSIONS” FOR NEGOTIATIONS
Consider applying levers that are not blanket discounts or decreases in price. Unlike discounts or price decreases, other levers can boost your brand and value perception. These levers or “dimensions” can include:
- Free trials
- Performance rebates
- Loyalty program
- Extended payment terms
- Increased service level
- Order efficiency discounts
Wherever possible, align with your customers’ outlook. Many of your customers may be concerned about insolvency or dramatically reducing headcount. Creating agreements that explicitly acknowledge these concerns can help you outperform in the crisis (see the third example below.) As a rule: Always focus on value over price.
Some examples:
- Create low-margin “bonuses” for good customers from slack capacity (increased support levels, extra training) or excess inventory
- As your suppliers drop price, expand the value you deliver to your customers. For example, when shipping prices drop, you may be able to “throw in” rapid delivery without changing the price.
- Hyundai famously offered a very generous lease-return agreement during the 2008 crash, reflecting many automobile shoppers’ concern that if they lose their jobs, they would be unable to meet high lease payments. This program is credited with establishing Hyundai as a serious competitor to better established brands, and is one of the reasons why Hyundai emerged from the crisis with double-digit market share.
4. RE-ALIGN YOUR PRICE STRUCTURE
Our studies have repeatedly shown that how you charge is more important than how much you charge. It is generally true that moving to longer-term relationships is beneficial in a crisis, because this lowers churn and protects your best customers. If your structure is purely month-to-month, smart discounting or better payment terms may help you create longer-term relationship, particularly for companies that are protecting cash.
However, some customers may be concerned about taking on commitments that they will not be able to honor or that will limit their options going forward. Others will be concerned about paying for anything they will not use. For these customers, moving some or all of your revenues to a pay-as-you-go model can be very effective in a crisis.
This is typically done by shifting from a pure license metric to a “license plus usage” or even pure usage metric. A usage metric can benefit you when:
- Prospects and customers are very worried about a slowdown in their demand cycle;
- Your customers’ headcount is shrinking, meaning that a license-based model would show high churn in terms of dollars, if not in terms of actual lost customers;
- Due to customers’ risk aversion, you can charge a premium for per-use, or avoid discounting
In addition to attracting new customers and retaining existing ones during the crisis, a well-thought-through usage metric can help you to out-perform when the crisis ends and usage really ramps up.
5. LABEL YOUR ECONOMIC CONCESSIONS, SO YOU HAVE AN “OFF” SWITCH
If there is no end to your discounts or concessions, it hurts your ability to recover along with the rest of the economy. To mitigate jeopardizing your long-term price integrity, consider:
- Creating rebates rather than discounts wherever possible
- Positioning concessions to reflect the crisis so they have a natural end date
- Emphasizing the connection to fairness
Key tip: When it’s time to withdraw these concessions, give customers and prospects a month’s advance warning. In our experience, this often spurs a significant spike of demand as businesses rush to take advantage of the “sunset” on the offer.
Key tip: Consider applying a “concessions matrix” to give you a structured way to deliver the right concessions to the right customers. (More on the “concessions matrix” in our follow-up, “Defensive Sales”)
6. MAKE IT A TWO-WAY STREET: USE CONCESSIONS TO MOTIVATE BEHAVIOR THAT BENEFITS YOU
Barter discounts for better relationships. Ask for something in return for the benefit you are offering. We often see companies offering discounts and other concessions to stop attrition with little or no connection to overall strategy. Instead,
- Create price breaks that are “deals in kind” for longer relationships
- Offer a discount spread out over months (multiple bill periods), rather than up front
- Steer other customer behavior using concessions
Example: Give a monthly customer the choice of a modest discount, or a steeper discount when they move to half-year or annual billing. However, be cautious about multi-year contracts in a period of forecasted economic volatility. Specifically, be sure you will be able to capture price increases in the recovery.
Example: When customers asks for a month free, offer a 33% discount for each of the next three months instead.
7. STRUCTURE A GRACEFUL DOWNGRADE MOTION
If your customers are in sincere need of an economic concession, give them alternatives to cancelling and save the deal – it’s often the case that your customers do not want to cancel, so give them alternatives!
If you’re lowering prices without lowering performance, you are simply lowering profitability. Rather than lowering price and offering the same exact product or service, consider the following actions in the short-term:
- De-bundle products and services (e.g. kill “nice-to-have” features for downgrade customers)
- Establish service price lists to balance price and performance
- Reduce performance and offer “good enough” solutions, the “less expensive alternative”
In many cases, the purpose of the “less-expensive emergency package” is to simply keep the customer alive, sometimes called a “heartbeat package.” This reflects the proven reality that it is easier to upsell and cross-sell an existing customer, than to acquire, or re-acquire, a new logo.
Make sure to position this package correctly, in two specific ways. First, prevent unnecessary cannibalization of other customers by only granting the LEA reactively, in response to a customer’s request. Second, position it as a “special temporary offer” connected to the crisis (see point 5, above.) Your customer is much more likely return to their “normal” state/package, or upgrade, if you handle this step and the others listed effectively.
8. ANALYZE INCUMBENTS FOR POINTS OF WEAKNESS
This is one of the most important points, and one of the most often overlooked.
While it’s not true that the Chinese word for “crisis” contains the word “opportunity” (sorry, Al Gore), by shaking up market incumbents, a severe economic shock often opens up avenues of advantage for the company quick enough to spot them.
First, you may be able to pick up new customers from poorly-funded competitors that are:
- Unable to offer the same concessions you are making;
- Showing signs of insolvency, since their customers will already be looking for alternatives;
- Actively shedding customers, for example to lower costs
With regard to larger competitors, the key is understanding this one-two punch: (1) In a crisis, large organizations often provide less support to their smaller, less profitable customers. (2) However, this is precisely the moment when many companies are open to a “good enough” alternative, at a better price, to the market leader. Your goal should be to:
- Identify your competitors’ customers that are the most vulnerable to being won away
- Create the right vehicle to attract these customers to you
Start by analyzing your well-established competitors on two dimensions. First, map their features against yours. Which of your competitor’s feature sets can you substitute for on a “good enough” basis?
Then, carefully study these competitors’ current response to the crisis. Are they applying discounts? Are they granting concessions? For all customers, or only “key accounts?” Is their messaging targeted to all their customers, or only the upper tier?
Once you know who you are going after, create a compelling offer. Consider a very deep, one-time deal, explicitly tied to the current crisis. To ensure you get full return for your efforts, “lock in” new customers through a long-term commitment, cancelation penalties, or proof that they have canceled with your competitor.
In summary: be targeted, plan for the downturn with the recovery in mind, and negotiate with new and existing customers thoughtfully. If you have any questions or find this feedback helpful, please reach out.
1Data at https://www.caixinglobal.com/index/; graph found at Seeking Alpha, https://seekingalpha.com/article/4335638-chinas-economic-growth-rebound-is-happening
2Reeves, M, et alia, Harvard Business Review, March 10: https://hbr.org/2020/03/how-chinese-companies-have-responded-to-coronavirus