This word has consumed headline news for over a year now across the globe. While it’s easy to associate inflation with price increases for items such as eggs or the price for an evening stay at a hotel, the underlying drivers can be a bit more complicated. Inflation, or the rate at which prices for goods and services ride, can be attributed to three primary drivers:
Getting paid more due to built-in inflation sounds great, right?! Only if the cost of living around you is less relative to your wage increase; otherwise, you may still be losing money each year relatively speaking. Unfortunately, as shown in the data provided by statistica, inflation has been beating wages for some time.
Given that we experienced a period where trillions of dollars were funneled into the economy as stimulus during the COVID-19 pandemic, it’s only fitting that a combination of the above inflation drivers kicked into overdrive. This presented both a risk and an opportunity for service organizations with respect to pricing strategies.
Regardless of the types and number of changes made during an inflationary period for parts pricing, agility and data are keys to success!
To quote Sir Isaac Newton, “For every action in nature there is an equal and opposite reaction.” The reaction to inflation is identified by what is called quantitative tightening and the change in interest rates:
The tools above have been put into play during the course of 2022 and continue to be used as 2023 is underway. The hope of central banks is that through these tools, inflation will come down but not at the expense of causing a recession. The process of inflation being reduced is known as deflation and has completely different implications for how service organizations will approach running their business.
Deflation – or a decline in prices for goods and services – is typically associated with a contraction of the money supply and credit in the economy. Prices declining means everything is great! Not so fast, let’s take a look at some of the challenges and opportunities that take place during this period:
Excluding the resurgence of purchasing power within the currency, it’s very apparent that the challenges above can create quite a headache for the service leader who owns the responsibility of the organization’s P&L.
To make matters more challenging for manufacturing companies and supply chain leaders, the past several years have been a textbook example of what is known as the bullwhip effect for some manufacturers and service organizations. This is a scenario in which small changes in demand at the consumer end of the supply chain become amplified when moving up the supply chain from retail to the manufacturing end. Manufacturers are often left holding significant inventory (or the proverbial bag) at the end of this sequence, which may or may not coincide with slowing demand. Carrying excess inventory in any situation is not looked highly upon; however, in today’s environment when the cost of capital is so high and the technology landscape is moving so quickly, the risks are amplified.
Companies often run campaigns or discount programs to move the excessive inventory but must balance this carefully to not destroy profitability. In a perfect world, lowering prices leads to a direct correlation with increasing demand and allows inventory to be reduced in line with company goals. This is also known as Price Elasticity of Demand. While some view this ratio as a means to increase total demand for a product, it’s Syncron’s view that demand doesn’t actually increase or decrease, but rather is shifted forward and backward in time. Additionally, demand may be shifted from finished goods sales at the OEM to the aftermarket in the event discounts are appealing enough for consumers to continue the operation of existing assets. Using another physics example, Syncron’s view on Price Elasticity of Demand is very similar to the Law of Conservation of Energy where energy can neither be created nor destroyed – only converted from one form of energy to another.
While not specific to aftermarket sales, a well-known example of this in recent months is Tesla. The car manufacturer dropped prices up to 20% for certain models to start 2023. The individuals who jumped on this deal and purchased vehicles were likely already interested in purchasing an Electric Vehicle. This move by Tesla shifted the timing of demand up in line with the discount offering window.
While the challenges associated with deflation can often be ominous from a top-line growth perspective near term, it does present an opportunity to increase customer base and brand loyalty. During deflation, companies really have two options:
Assuming companies elect to go with option 1 (fingers crossed as a consumer), they can’t just blindly reduce their prices in a race to $0. There are three questions that need to be addressed in order to develop a comprehensive strategy:
With consumer expectations increasing at a significant rate, it’s critical that data be available on a consistent basis to support these questions as part of an ongoing business review. As we all know from the past several years, market sentiment and economic conditions can pivot on a dime. The importance of data and technology cannot be overstated as a means to driving a successful pricing strategy in aftermarket parts organizations.