We have all realised, with direct impact on our daily lives, how the last few months have seen a sharp rise in inflation, with levels not seen for decades in Europe. In fact, we speak of inflation when there is a far-reaching increase in prices, which is not limited to individual items of expenditure. This means that with one euro you can buy fewer goods and services today than in the past. In other words, inflation reduces the value of money over time.
The rise in inflation, in some of the last few months even exceeding 8%, is due to a variety of factors, the latest of which is the conflict in Ukraine, which has pushed up the cost of raw materials and energy. If we take as a reference the optimal level set by the ECB and equal to 2% inflation per annum, we can easily understand how current values can shift not only production costs, but market demand itself.
Inflation and prices, target margins
In such an easily changeable scenario, the first objective of companies is to be able to maintain production despite the sharp rise in raw material prices. It is precisely on this point that some companies, because of the growth in the energy component and in particular gas, have preferred to stop production instead of increasing the final prices for their customers by three or four times.
In this scenario, the choice of pricing becomes even more relevant both to maintain market share and to keep good profits. With an exponential increase in costs, companies are at a crossroads, on the one hand not to eat into margins too much and on the other hand to pass the increases on to the customer at the risk of losing market share.
On this issue, McKinsey recently produced a study Five ways to adapt prices to inflation from which some fundamental concepts emerge, such as the fact that a mere price increase in the context of inflation can damage the relationship with customers and that pricing processes must be redefined, safeguarding the price of key products or services, on which consumer sensitivity to price is greatest, and aiming to speed up the decision-making process.
Inflation and prices, the importance of forward-looking analyses
From a long-term perspective, it is inevitable for companies to adjust prices to inflation, but if we talk about a short to the medium-term horizon then the choices made can have very significant impacts. Let us take an example in a very competitive market with low margins such as the retail market. In this case, the choice of pricing not only determines market share but even the profitability of individual sales.
Very often there are thousands of SKUs in the catalogue with significantly different pricing logic; in the last ten years, the various players have been able to overlook an important variable such as inflation, but one that will have to come into play in the future evaluations. Precisely to better assess these impacts, as well as those of other key variables in pricing, companies should use AI-based pricing tools and predictive demand models.
Indeed, forecasting analyses make it possible to hypothesize different scenarios to assess the potential impact of a given increase. The predictive aspect is crucial for anticipating changes in demand before it has a real impact on the market, thus helping management to make certain strategic choices.