Alexander McKay is co-director of Harvard Business School’s Pricing Lab, a research center dedicated to studying how companies set prices. Since the pandemic, he has observed how companies have become more willing to experiment with how much they charge customers.
Major companies, which previously enforced standard price increases once a year, are now raising prices more frequently. Retailers are increasingly using digital price displays that can be changed at the touch of a button. Across the economy, profit-maximizing executives are effectively testing consumers to see what prices they will pay before they stop buying.
Mr McKay said massive supply chain disruptions during the pandemic have increased business costs and forced many companies to think more creatively about their pricing strategies. This has accelerated the trend towards tighter pricing and shown that many companies can manipulate prices more aggressively without scaring away shoppers. Experiments continue even as costs ease.
“Price changes may occur sooner than they have in the past,” he said. This could mean going up or down, but companies are usually more eager to raise prices than lower them.
Companies are looking for ways to protect the profits they’ve made since the pandemic. For large companies in the S&P 500 index, average profit margins (profits as a percentage of sales) declined from the end of 2020 to 2021 as government stimulus and emergency Federal Reserve intervention stimulated consumer demand. It skyrocketed. At the same time, companies have been able to raise prices significantly to more than cover the rise in energy, transportation, labor and other input costs, which have recently begun to fall.
Companies as diverse as Apple and Williams-Sonoma recently reported record profit margins in the third quarter, while Delta Air Lines announced its international flights posted record profits over the summer.
Margins fell slightly last year, but have recently rebounded to levels that would have set records before the pandemic. Average returns for nearly every sector of the S&P 500 are near or above 10-year highs, according to Goldman Sachs.
“Companies are maintaining or increasing their profit margins because they’re not passing these cost savings on to consumers,” said Albert Edwards, a strategist at Société Générale. He called it “despicable.”
Companies are now figuring out how to set prices to protect profits during what could be a turning point. High interest rates and reduced savings have made some, but not all, shoppers more price-sensitive.
Many companies may be able to protect profits simply by stabilizing prices as their own costs fall. But some are still wondering whether they can push prices higher as demand cools and overall inflation falls.
“I don’t think companies have the monopoly power to raise prices at will,” said Ed Yardeni, president of research firm Yardeni Research.
Margins are more important than market share.
Many companies talk on earnings calls about how they prioritize profit margins, even if it means slowing growth.
Take Cisco, a food wholesaler, for example. The company’s CEO, Kevin Hourican, said in an October earnings call that business in the domestic market has slowed recently.
But “Cisco hasn’t responded by taking price leadership to gain market share,” he said, referring to the tactic often used during economic downturns to lower prices to attract more customers. did. “Instead, we are focused on profitable growth.”
Heating and air conditioning company Lennox is working to perfect its pricing strategy based on years of data., The company’s CEO, Alok Maskara, spoke at an investor event this summer.
He said industry players are “focused on margins and revenue,” suggesting that a small number of profitable sales are preferred over many unprofitable sales.
This is a change from practice since 2009.
The focus on improving profit margins, even if it means lower sales volumes, is in some cases a shift from conventional wisdom during the 2009 recession and in the years that followed. At the time, some executives felt they needed to compete on price for cost-conscious shoppers. For hotels, that meant focusing on filling every room.
“If you think back to the Great Recession, the idea was to keep interest rates low until people got better,” Marriott Chief Financial Officer Reenie Oberg said. Meeting with investors in September. She added that “that wasn’t always the right strategy.”
Now, she says, “the industry has clearly learned some lessons.” Over the past few years, the company has sought to achieve a greater balance between revenue and profit maximization, she said.
Retailers, struggling with changing consumer tastes in recent years, are increasingly talking about “inventory discipline,” or holding fewer products in stock to avoid selling at clearance prices. There is. The logic is that it’s better to run out of product and sacrifice some sales than be forced to cut prices in a way that makes sense for the bottom line.
Clothing chain American Eagle Outfitters is growing profits by “maintaining tight inventory and promotional discipline,” CEO Jay Schottenstein said in a statement. This was stated at a financial results conference in May.
Companies have learned that they can charge more than they bargained for.
As prices rise, consumers cut back on some purchases, but that’s not universally true, so it’s worth experimenting. Robert J. Gumgort, CEO of Keurig Dr. Pepper, recently said that consumers have shown little response to the soaring prices of carbonated soft drinks.
This, he said at an investor conference in September, referring to the recent period of inflation, suggests that the value was “too high to start at this point.” “It was cheap.”
The company raised prices in its U.S. beverage division by 7% last quarter and highlighted “significant gross margin expansion” on top sales. Latest financial report.
Some executives have realized that they can charge more by branding something as a luxury product or experience.
“Despite the current economic environment, consumers continue to trend towards premium amenities,” Melissa Thomas, chief financial officer of movie theater chain Cinemark, said on an earnings call in November.
However, price sensitivity may return.
Cereal company Kellogg’s has weathered significant price increases without losing customers, a situation economists refer to as price inelasticity. It’s like cutting a rubber band (raising prices) but not reacting (shoppers keep buying).
Recently, however, consumers have started to withdraw from the product due to sticker shock.
“Price elasticity is having a pretty significant impact on the market,” Kellogg CEO Gary Pilnick said on a conference call with analysts last month. “You may remember that we’ve had price increases of about 35% over the past few years, and the elasticity has been fairly modest for quite some time.”
Even brands aimed at lower-income consumers, such as Walmart and McDonald’s, are showing price sensitivity and expanding as wealthy customers seek deals.
McDonald’s Chief Financial Officer Ian Bowden said in an October earnings call that “we continue to grow our share in both middle-income and high-income groups,” but the company He pointed out that low-income customers are struggling.
Our ability to increase prices or keep prices high may not last long.
While companies are getting creative to protect their margins, the economy is also holding up better than most expected. Overall growth remains rapid, consumer spending is rising, and the long-warned recession has been avoided.
The question is whether companies can protect their profits in an environment where this momentum slows.
“Clients are rebounding,” said Paul Donovan, chief economist at UBS Global Wealth Management. “We’ve reached that point of resistance.”