“You Can’t Price Your Way Out of a Recession”

Mark and I were teaching a certification class about our book Pricing with Confidence at the  Professional Pricing Society in Houston last week.  We were talking about our famous “dirt” company (you’ve got to read the book!) and repeated a quote from their CEO: “You Can’t Price Your Way Out of a Recession”.  Someone asked what we meant by that.  Given the number of companies that we’ve spoken to in the past month that are still thinking about using price discounts to achieve: a) increased share, b) increased revenue c) increased profits or d) cover increased costs, it’s worth it to give you the answer too.

In mature markets or economic downturns, demand is down.  That is, customers slow their purchases.  This is true for consumer sales where demand year over year is down 10% in retail and 50% in automobiles.  And, it’s true in business to business sales where declines seem to be in about the same range except for health care which continues to show increases in demand.  By definition, those markets are “inelastic”.  That is, demand does not respond (increase) that much due to changes in price. 

When markets mature and demand becomes inelastic, price strategy for all products and services should stay skim, where you price high relative to competitors or evolve to neutral, where you stop using price as a competitive weapon.  If you try to use price to increase sales, competitors respond and price wars break out.  When that happens, revenue drops (a characteristic of inelastic markets) and profits disappear.  And, during all of this demand keeps going down and it never goes up.  It really is simple.

During the holiday season, we saw many retail companies try to use price discounts to increase demand.  As a result, it is likely that many of those companies will go out of business.  Some analysts predict that there will be “massive retail bankruptcies in 2009 and 2010“.  Reuters reported that “Restructuring experts see a wave of retail bankruptcies in the coming months due to dismal sales and a credit crunch.”  What is interesting to note is that they failed to point to pricing strategy as the culprit, yet it is.  The reason that many retailers are going out of business over the next two years is not because demand is down.  It’s because they are using price discounts to try to fix a problem that just can’t be fixed.  Business is going to be down for most of us for the foreseeable future.  It’s time to batten down the hatches and try to survive.  Cut costs, put people on furlough, stop unecessary expenses but don’t discount price.  By using price discounts at the wrong time, retailers eliminated profits and sealed their fate with the bankruptcy courts. 

We talked about Abercrombie in January because they decided to stick with their skim pricing strategy in December.  Lots of analysts thought this was wrong.  Even some of our own people agreed with them.  Yet most recent results for Abercrombie shows that while profits “plunged” 68%, their stock price is actually up 10% because investors know that a) they’ll survive and b) they have protected their high value position in the marketplace while many of their competitors (even Macy’s!!!!) have pulled the panic lever and started dramatic discounting.  Against the advice of many, Abercrombie used the correct price strategy and will survive the downturn.

What about the dirt company?  Most recent results show that their revenue is up and profits are up more.  They too will do just fine.  Not without a little sweat but smart managers use recessions (maybe even a depression!) to tighten up controls and policies.  They limit spending.  They adjust their revenue goals down.  They get people working smarter and better.  The one thing they don’t do, is use discounting to try to solve the problem.