Dear Friends,
After months of uncertainty, the tariff dust has settled for most US trading partners and industries. US tariffs will average around 10-15%, with variances by country and sector. These historically high tariffs mark the largest increase since the disastrous Smoot-Hawley Act of 1930. While a few more changes may still occur, we don’t expect a return to the low or negligible overall tariffs of the past decades.
Back in January, we wrote that tariffs of these magnitudes – if implemented – will throw almost every company’s pricing strategy off its axis. That time has arrived. Businesses selling in the US now need to decide what they want to do with their prices. My co-author Arnab Sinha will talk through strategic choices in this edition of the newsletter.
But first … this week’s inflation surprise
The first clear sign that companies are adapting their pricing strategies came this week. The July consumer inflation rate in the US came in roughly as expected, most likely because the tariff uncertainty and delays of the past months drove most businesses to take a cautious stance. But the producer price index (PPI) surprised markets yesterday morning with its largest monthly increase since June 2022. While there is no doubt consumer inflation will eventually pick up, it remains unclear whether this will be a one-time increase or a sustained period of inflation. The policies of the US Federal Reserve will have a significant influence here.
Our advice to businesses on managing these pressures: be strategic, not reactionary. Many will have no choice but to build the cost increases into their prices, despite the heightened sensitivity from customers and consumers. Their volumes and growth will suffer. But other businesses may have the degrees of freedom to hold back, observe their competitors, and then decide when and how to follow. Still others may anticipate a strong consumer backlash from higher prices, but have sufficiently high margins that allow them to absorb some costs and turn the economic pressure into an opportunity to gain market share.
The powerful role of pricing strategy
In Game Changer, we defined a pricing strategy as a business leader’s conscious decisions on how to shape their market by determining the amount of money available, how that money flows, and to whom. It reflects the company’s philosophy on how to acquire, retain, and satisfy customers by sharing value with them fairly.
How companies now share the burden of the higher tariff costs is a moment for pricing strategy – and the tools and teams that support it – to shine. A first step is for companies to understand that they no longer need to operate under what we refer to as “the high-low anxiety of zero‐sum pricing.” That anxiety builds when managers and executives oversimplify the effects of higher costs by using zero-sum logic: pass on too much of the costs to customers, and you become less competitive and risk losing market share. Pass on too little, and your bottom line may suffer relative to your peers.
That logic implies a single Goldilocks answer to a problem that is much more nuanced and complex. To paraphrase what some of our colleagues wrote over a year ago, the magic happens when companies figure out how to turn the complexity of their markets from an obstacle into a valuable resource.
How precisely should companies become more accomplished at sharing the cost burden of high tariffs? There are a few ways, including some that we laid out in our final edition of this newsletter in 2023, long before the tariffs were on anyone’s radar, and in a series of posts last winter as the first tariff proposals came out.
- Stop taking an aggregated view of markets and prices: We sometimes refer to this as de-averaging. Price sensitivity, purchase frequency, and tradeoffs can vary considerably by customer segment and even at the individual level. The ability to adjust prices by segment, location, time, and other factors creates opportunities for companies to spread the cost burden out more fairly.
- Use advanced tools: Yes, we know you are tired of hearing about all the things that artificial intelligence can accomplish. And we know first-hand that humans with spreadsheets can work wonders. But as we have said before, pricing is one area where these advanced tools are already having a rapid and significant impact. Any business that serves diverse customer segments with a large portfolio of products can benefit from the speed and transparency that these advanced tools provide.
- Understand your pricing game: Almost every company plays one of seven distinct pricing games, depending on their specific market environment, its competitive intensity, its buyer fragmentation, and its level of product differentiation. This means that there are no off-the-shelf or textbook responses to tariffs that apply universally. What works in one pricing game may be ineffective or destructive in another game.
How tariffs affect each pricing game
Companies still have a lot of agency in this new world of higher tariffs.
To respond to tariff pressures, players of the uniform game – such as consumer goods companies, retailers, and some industrial suppliers and distributors – will need rich, near real-time data on their consumers and customers so that they can avoid blanket price increases, put price sensitivity into perspective, and assess their opportunities and risks.
Players of the cost game – which include some industrial suppliers and government contractors – need to move quickly to protect their usually thin margins. They need to reassess their cost and margin structures, act quickly when they have opportunities to raise prices, and use incentives to help offset price changes if needed.
Players of the power game face a small number of strong competitors and serve a handful of powerful customers. They need to be keenly aware not only of how tariffs will affect competitors and customers, but also how second-order effects of their decisions may affect the overall market equilibrium.
In the Custom Game, which includes most industrial suppliers, the key steps right now are “read, react, and adjust.” Companies should review their contracts in detail and see how existing price adjustment mechanisms apply to higher tariffs. They should also listen closely to what their sales teams are saying and look for opportunities to move first.
Players in other games may have additional levers for sharing the cost burden fairly across customers. The classic idea behind bundling, for example, is that a customer with a high willingness to pay for one product and a low willingness to pay for another will buy both products as a bundle at an acceptable price. The long success of bundling in the telecom sector shows how the approach can make both customers and companies better off. This is a common strategy in the Choice Game.
Tariffs are now the “mother of invention” in pricing
The age-old proverb states that “necessity is the mother of invention.” Right now, for businesses selling in the United States, that necessity is tariffs. The approaches we mentioned above are not entirely new, but the pressure to implement them was lower over the last few years when many companies successfully implemented multiple price increases. Their leeway to continue that process was already limited by shifts in consumer behavior before the tariffs hit. If tariffs are the spark that compels companies to become more creative and flexible in how they adjust their prices, that will be a pleasant side effect, no matter how the tariffs play out.
Original article can be found here.