Pricing in Inflationary Times

Pricing for multi-year contracts used to be a little more straightforward than now, in these times of high inflation. To a large extent, as long as within the lifetime of the contract the scope did not change, you could use a simple method - work out the price for one year of delivery and multiply by the length of the contract.

Now, there is considerable risk involved in using that method, as your costs will probably increase (perhaps considerably) simply due to inflation, and the cost for some raw materials is highly volatile.

How you approach the price you will quote depends a lot upon your customer’s attitude; some are happy to renegotiate the price each year, while many want certainty up front and try to push any risk onto you, the vendor.

So how to approach this?

There are several ways to manage future cost changes; here are three simple ones.

First, you can use a published inflation forecast to model how costs will change over the lifetime of the contract, and then build that cost inflation into your price. Of course, you have to have some faith in the accuracy of the forecast, and forecasts can be wildly wrong. Also, this means that your total contract price will be higher than a simple multiple of the annual price, which might put you at a disadvantage compared to your competition.

Second, you can quote a price based on the price for a year multiplied by the contract length, and include a clause saying that the price will increase each year based on the published inflation figure. This protects you, but as mentioned this creates uncertainty for the customer which might not be acceptable.

Third, you can offer a hybrid price; a fixed price covering those costs where you have a high degree of certainty, and provide a ‘market price’ for the highly volatile items, perhaps including a management fee, so you simply pass those costs on to the customer.

The really smart thing, though, is to offer all three to your customers. Tell them that they have three options with regard to how inflation is managed, and ask them which they prefer.

This puts them in charge. Psychologically, their choice moves from ‘yes or no to the price that has been quoted’ to ‘which of these price approaches is best for me’.

Plus, you can use three options as an anchor. Present all three, and start with the one that has the highest number first (which would be the fixed price with inflation built in). That price becomes the reference against which the other two options are compared, making them seem like better value.

There are more approaches than these three - for example, a fixed price with a clause that triggers a price renegotiation if certain costs increase or decrease by more than a certain % - so offer the three options that make most sense for you and your customer.

#pricing #pricingoptimization #pricingstrategy #inflation