Key Takeaways
- Raw material cost volatility can put pressure on margins, making strategic pricing essential for protecting profitability.
- Assess how changing raw material costs affect products, prices, demand, and overall profits.
- Use dynamic, value-based, or calibrated pricing approaches to respond to changing costs and protect margins.
- Train sales teams and monitor pricing performance to communicate price changes and manage profitability.
Many industries, including groceries, white goods, technology, and automobiles, face changing and sometimes unpredictable input expenses, including raw material cost fluctuations. Making a profit has also become incredibly difficult. You might be thinking about adjusting your prices, but doing so can be tricky in an unstable business environment.
Price adjustments are not always well received by customers.
Some customers may find pricing changes dismaying, inconvenient, or difficult to accept. But what if your input costs, particularly raw material costs, continue to fluctuate? How can you keep your customers’ confidence and remain profitable? There’s nothing wrong with modifying your prices in these difficult times, but it has to be strategic.
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In this article, we provide the best advice on how to optimise your pricing strategy to counteract escalating and unpredictable raw material costs, allowing you to retain customers and profits. First, we’ll go over the basics of input and raw material costs; then, we’ll explain why raw material prices can increase and fluctuate.
Following that, we demonstrate how pricing can protect businesses from the risks of unpredictable production costs. Finally, we present a step-by-step method for pricing your products and services in the face of cost volatility.
At Taylor Wells, we believe that businesses can readily respond to input cost inflation and fluctuations by working on pricing efficiency to prevent negative effects on profitability. By the end, you will understand how to manage fluctuations in raw material costs and prepare your company for potential challenges.
How can businesses manage fluctuating raw material costs?
Businesses can manage fluctuating raw material costs through a strategic pricing approach that combines data, customer value, and regular monitoring. The article recommends four key steps:
- Assess the business implications of raw material costs. Review past and present costs, transaction records, agreements, and pricing data to understand how cost changes affect products, prices, and profitability.
- Consider dynamic pricing. Adapt pricing to the business and economic environment. Depending on the type of business, this can include delaying cost increases, using analytics to anticipate changes, or applying value-based and calibrated price increases.
- Train sales teams to explain price changes. Give salespeople the confidence and preparation to discuss pricing changes with customers, producers, and distributors.
- Oversee pricing and profitability. Monitor pricing performance regularly, establish clear approval procedures, and use pricing teams and analytical techniques to identify opportunities and manage risks.
Together, these measures can help businesses respond to cost volatility while protecting margins and maintaining customer confidence. The first step is understanding exactly how changing raw material costs affect the business.
See whether your pricing is under controlStrategic Pricing When Input and Raw Material Costs Are Unpredictable
In times of business distress, pricing should be a top priority. Yet, many executives are hesitant to think about the consequences of rising raw material costs on their selling prices. This hesitation may stem from concerns that price changes could harm their relationships with customers. Even so, we think there are approaches to modifying prices while being profitable. To begin, let us define input costs and raw material costs.
What do input and raw material costs mean?
From traditional trading routes to today’s global markets, raw materials have long played an important role in economic activity. Raw materials encompass petroleum products, gas, metal, plastic, wood, and many more. What do we mean when we say raw material cost?
The cost of raw materials refers to the amount required to purchase the resources businesses use to produce a product or service. In many cases, the cost of raw materials guides businesses in establishing the final price of the item that they intend to sell. They set a budget for raw materials by calculating how much they will consume over a specific time. This practice, however, has become increasingly difficult.
Most raw materials are derived from natural assets, which can be in low supply and frequently constrained. Since raw material costs can fluctuate, firms must be familiar with their dynamics. Raw material costs are affected by supply and demand; therefore, businesses should keep this in mind when conducting procurement.
It is crucial to carefully assess the amount of raw materials you acquire. If you order too many, they may deteriorate and become unusable over time. Nevertheless, if you do not purchase sufficient raw materials, costs may escalate, forcing you to alter your budgeting. To properly manage your raw materials, you must grasp the variables that influence price fluctuations.
What causes the fluctuation and rising costs of raw materials?
Raw material costs can be affected by supply shortages, geopolitical disruptions, energy prices, and changing demand. These pressures can make production costs more difficult to predict and increase the need for businesses to monitor costs and adjust pricing accordingly.
Raw material costs can fluctuate significantly around the world, including in Australia, depending on factors such as supply, demand, energy prices, freight costs, and broader economic conditions. Here are some of the reasons why:
- Changes in consumer demand and distribution patterns can also affect the cost and availability of packaging, transport, and other inputs across the supply chain.
- China remains a major source of global commodity demand, particularly for industrial raw materials, so changes in its industrial activity can influence commodity prices and supply conditions.
- Construction and timber markets can also experience cost pressure when demand, freight costs, material availability, or production capacity change. Weather events, pests, and supply constraints can add further uncertainty.
All of these factors, along with many others, affect supply and demand and put substantial pressure on small and medium-sized businesses, as raw material costs often represent a significant portion of production expenses.
How can pricing counter raw material input cost inflation and fluctuation?
Rising raw material costs and instability are troublesome, but they also create an opportunity to improve pricing and strengthen business practices. You must approach these changes strategically; otherwise, your profits may suffer.
What characterises an effective pricing strategy? It is founded on modern data analytics, driven by customer value, and supported by systematic pricing processes. With strategic pricing, firms can manage input cost inflation and fluctuations more effectively while reducing the risk of negative financial results.
A strong pricing strategy can help prevent a business’s financial condition from deteriorating and mitigate the impact of supply scarcity. In a changing business landscape, regular monitoring, assessment, and adjustment of pricing, as needed, enable organisations to adapt effectively and minimise the risks of unpredictable raw material costs. Furthermore, it may assist companies in producing stronger financial results as market conditions change.
What’s the best way to set prices when raw material costs fluctuate?
1. Assess the business implications of raw material costs.
For starters, gather your transaction records and data. Get hold of critical agreements, especially legal commitments and negotiations. You will make use of your historical and present cost data. Then, review your measurements to accurately analyse how changes in raw material costs have affected your product prices. Evaluate the efficiency of your cost, resource, and demand forecasting.
An analysis that shows how cost increases could affect pricing and profits will help you develop a pricing strategy based on data insights and not just intuition. Moreover, this assessment will help you identify the rationale that you and your sales teams need to interact with customers credibly and consistently. The key benefit is that you may set a long-term pricing strategy to ensure sustainable profitability.
2. Consider implementing a dynamic pricing strategy.
A smart and dynamic pricing strategy can safeguard your profits during input cost inflation and fluctuations. However, the mechanism must be adapted to your business and economic environment. Do you operate a price-sensitive business that sells commodities? We know that the cost of raw materials heavily influences this type of business. In this case, it is important to consider ways to delay passing on costs without reducing income.
While this approach may be useful for a commodity business, it may be less suitable for a company offering specialised, distinctive products and services. How should this type of company price its products? We have observed that successful businesses in this field use analytical tools to anticipate changes in raw material costs and supply-demand imbalances. Consequently, they have established processes to modify their prices.
Depending on the circumstances, businesses can use a value-based approach to pricing changes or a more gradual, calibrated price increase to sustain margins as fluctuating raw material costs flow through production and inventory and ultimately affect the prices of products sold.
Businesses can also explore agreements with different raw material suppliers, modify product components to reduce the impact of raw material costs without sacrificing product quality, and revamp conventional costing procedures.
3. Train your sales team to explain the value of price changes to customers.
Offer extensive training so salespeople feel confident discussing pricing changes with clients, producers, and distributors. For instance, you may host activities where sales teams act out customer discussions in a range of circumstances.
Various businesses we work with implement comprehensive performance improvement training. This includes coaching, evaluation, rewards, performance indicators, and advanced analytical pricing techniques. All of this serves to increase sales confidence and commitment.
4. Oversee your pricing strategy and how it affects your profits.
Implementing explicit pricing approval procedures and clarifying management and performance systems can help. These systems should outline how customer queries are addressed and what evidence and authorisations are needed to approve exemptions from a scheduled price increase.
Pricing processes and performance assessments are usually too slow to deal with fast-paced situations. Management must be able to determine quickly whether the company is on track to meet its goals. This entails reviewing performance weekly or daily to identify where more attention is needed. If you do not already have a pricing team, we believe you may benefit greatly from employing one.
Our consulting and research experience shows that, with the right setup and pricing team in place, businesses can identify opportunities to improve pricing performance and profitability. Over time, well-researched price management techniques can also create additional margin opportunities as teams identify previously unrealised efficiencies and pricing improvements.
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Bottom Line
The unpredictable cost of raw materials can be alarming. In our work with numerous firms, many delayed changing their pricing approach because they believe they lack the necessary data and analytic capabilities. That isn’t always the case, though; most businesses have enough data to conduct fundamental analyses and take action.
Businesses that recognise the value of these strategies can put them into action and invest further in their systems to identify additional pricing opportunities. When combined with management initiatives, your company can succeed in managing fluctuations in raw material and input costs, including future inflation.
For a comprehensive view on integrating a high-performing pricing team in your company, download a complimentary whitepaper on How to Hire and Train Pricing All-Stars.
Are you a business in need of help to align your pricing strategy, people and operations to deliver an immediate impact on profit?
If so, please call (+61) 2 9000 1115.
You can also email us at team@taylorwells.com.au if you have any further questions.
