Inflation Pricing Strategy

Inflation peaked at 40-year highs in many countries in the early 2020’s. Since then, the headline inflation rates have trended closer to official government targets, but the threat of inflation remains an ongoing concern for businesses in many sectors.

How should a company respond when it sees upward pressure on prices, either on the demand side or the supply side? The easy answer is to treat that question as a simple math problem: how much do we need to raise our own prices to compensate or keep up?

But that view is myopic. The problem is that there are no easy, standard, or off-the-shelf answers for an inflation pricing strategy. A business needs to identify the patterns in cost changes, determine their underlying causes, and anticipate their duration. Then it needs to assess the potential effects, understand trade-offs, and choose the strategic and tactical responses that will lead to the best outcomes.

Those outcomes could be defensive to protect margins or customer relationships, or could be moved on offense to capitalize on opportunities to reset or recalibrate the portfolio.

What Is Inflation Pricing Strategy and Why It Matters

An inflation pricing strategy is the umbrella name for how a company responds to rising cost pressures. The actions might range from tactical moves to respond to transient cost changes all the way up to a fundamental shift in the company’s pricing strategy.

Most businesses have several price-related options as well as options that have nothing to do with price. These include launching new or modified products, repositioning products, renegotiating supply agreements, or reinforcing a value proposition. When a company instead focuses too narrowly on price increases, it overlooks several options that could make the business better off. Think of how restaurants have responded to cost pressures in recent years. They had increased prices faster than inflation, but Chili’s offset some of those increases by pushing a “3-For-Me” promotion. Waffle House implemented a temporary surcharge on eggs instead of raising basic menu prices further.

How Rising Prices Reshape Pricing Logic

All seven pricing games have an underlying pricing logic. Cost pressures may become so intense that the company needs to review its pricing logic and perhaps switch price models or switch games.

Determining whether such a move is necessary starts with a deeper understanding of the cost pressures themselves. The company needs more information about inflationary pressures so that they can build scenarios and make better decisions:

Causes: The practical day-to-day causes can include higher demand, acute supply shocks, or greater pricing power due to higher market concentration. These explanations are more precise and less abstract than the classic economic views. One classic view is that inflation is “the market being the market” or the aggregate result of how individual companies respond to supply and demand signals. Another classic view is that inflation results from increases in the money supply. The economy has too much money chasing too few goods. Let’s stay practical and sector-specific.
Duration: The duration of the inflationary period is often more important than the inflation rates themselves. Some inflationary effects are “transitory” while others are “persistent” according to the terms used by the US Federal Reserve. A transitory or isolated spike in costs often results from a short-term supply disruption from a geopolitical event, a natural disaster, or an industrial accident. A persistent inflationary period can result when events affect multiple interrelated sectors, when governments formally change policies, or when macro events result in permanent changes such as lower capacity or access constraints.
Volatility: Whether transient or persistent, cost pressures may be volatile as businesses assess the ongoing risks, act in unexpected ways, or deal with unintended consequences.
Business economics: This covers how cost increases affect how the business operates. How will customers respond, and will these changes endure? How will suppliers adjust and how will relationships with them change? Will some competitors be affected more than others?

The announcements of US tariffs in early 2025 created a need for companies to develop inflation pricing strategies. Based on the information above, some decide whether potential cost pressures warrant a defensive response (such as preserving margins or customer relationships) or an offensive response (such as pursuing higher share, marketing value more aggressively, or capitalizing on market expectations for higher prices). At the time, my colleagues and I recommended three process steps:

Review your value proposition: Ask yourself how you create value for customers and how cost pressures will alter your value proposition.
Develop scenarios for how to play your pricing game: Use these scenarios to create a heatmap of risk exposure and opportunities.
Expedite your processes: Act “by the market” rather than “by the textbook.” Anticipate and react to changes in many parameters at the same time. Flexibility and vigilance are paramount.

The more resilient and robust the business’s pricing process already is, the more flexibility the company will have to avoid margin squeeze between higher costs and adverse customer changes. It will also be better positioned to seize opportunities that inflation can create. A robust pricing process includes intensive tracking of costs, customers, and competitors so that the company can make better forecasts and reduce the risk of surprises. Many companies have treated inflation as an opportunity to make long-overdue changes to pricing practices.

Cost Inflation and Pricing Pressure

The common challenge of inflation is cost inflation on the supply side. Companies usually need to decide how much of the costs to pass through to customers and how much to absorb. Either decision can reduce profits because of lower sales or smaller margins.

Demand Sensitivity During Inflation

Customers may tolerate justifiable price increases based on costs, but depending on the causes, volatility, and duration, customers may change their behavior. They may buy less, hoard goods, or trade down to less expensive goods. One important question is whether demand will recover or return to previous patterns when prices stabilize.

Competitive Responses to Inflation and Pricing

Companies act in their own self-interest, but the situations and responses of competitors can create opportunities. Are competitors facing similar cost pressures? If they raise prices to offset cost increases, is it better for you to go after share gains or respond with a non-price action?

Maintaining Value Perception During Price Increases

A change in price should reflect a change in value, and the company needs to communicate both sides of the coin carefully to customers. Otherwise, customers might draw their own conclusions and perceive higher prices as unfair, manipulative or deceptive. Effective communication helps the company control the narrative.

How Inflation Affects Business Economics and Strategy

The term “shrinkflation” is a good way to illustrate how inflation affects business economics and strategy. A company cannot keep price, quantity, and quality all constant when costs increase materially. Something must give. If the company doesn’t raise prices, it needs to reduce either the quality of the product (less expensive ingredients) or the quantity (smaller packages). The latter case is known as shrinkflation.

Fortunately, companies can look beyond this myopic and simplistic view and consider other options, depending on what pricing game they are playing.

Cost Game: Change your delivery fees, implement raw material surcharges, or offer volume discounts in ways that balance efficiency and margin management
Uniform Game: Offer trade terms, promotions, and coupons. You can also deconstruct prices to align with drivers and model changes to price elasticities
Value Game: Reinforce the value proposition
Choice Game: Implement surcharges, offer promotions, and beef up loyalty programs
Custom Game: You have several options to manage complexity across customers: volume discounts, regional and segment adjustors, and discretionary deal concessions. You can also use raw material surcharges or escalators.
Power Game: Options depend on changes to competitive leverage. Can you offer temporary promotions for new products or work out customer agreements to offer supply chain support?
Dynamic Game: Options include promotions and coupons as well as shipping fees for small orders

One important step is to take a segmented, differentiated view of customers. The effects of inflation can vary significantly at the sub-category and sub-segment level. The challenge lies in balancing price increases and decreases that help you meet your objectives.

understanding Influencing price perception

How Rising Prices Reshape Value Perception

Two psychological effects can influence customer value perceptions when companies respond with an inflation pricing strategy. One is the price anchoring effect. Customers make comparisons based on reference points or anchors. They develop their own sets of reference price points, especially if prices remain relatively stable over long periods.

Sharp price increases can shock customers when they conflict with anchors, but companies can mitigate this effect with strong communication efforts that help customers get accustomed to new price levels. Companies can also mitigate the effect by making smaller gradual price increases that customers are less likely to notice. Those increases remain under the psychological threshold of a “just noticeable difference.”

Over time, a new equilibrium usually emerges and the majority of customers are likely to accept the new reality and revert to prior purchase habits at new anchor prices. For many less affluent consumers, however, trading down and buying on promotion will be a new way of life.

When Cost Volatility Meets Pricing Strategy

Inflation and Supply Chain Cost Shocks

These shocks occurred frequently at the height of the Covid-19 pandemic when ships could enter ports or companies could not get their raw materials. Many are transitory, so the challenge is to manage customer expectations and perceptions until conditions stabilize. Overreactions could lead to unintended consequences.

Supplier Pricing and Margin Compression

This is where inflation becomes a cost management challenge as well as a pricing challenge. Margins will get squeezed unless the company can change its relationships with suppliers or customers. Many B2B contracts already include provisions for cost changes to raw materials such as metals or chemicals.

Inventory and Procurement Strategies During Inflation

Cost management involves more than trying to mitigate cost increases from suppliers. Companies can also find opportunities to modify supplier relationships, identify and tap into alternative supply sources, or decide what tasks it could eliminate or take inhouse to make its sourcing more secure, manageable, and efficient.

Pricing Adjustments in Volatile Supply Chains

Surcharges help companies adjust prices during periods of volatility. They are more flexible than direct price increases, because companies change them dynamically, make them customer-specific, and eliminate them when they need subsidies. How airlines unbundled some services shows how surcharges or separate price elements can better align costs, prices, and demand.

Strategic and Tactical Trade-offs in Inflation Pricing Strategy

Deciding what trade-offs to make depends on your company’s objectives. A company focused on short-term profits may lean toward price-driven responses or aggressive cost management moves, while a company with a focus on longer-term profits may look at alternatives such as changes to the portfolio, the launch of new products, new supplier relationships, or a repositioning of products.
Who makes the decisions also matters. Regardless of how large your pricing team is or where it reports, you will need an end-to-end team to find the right ways to fix your pricing strategy. This means involving supply chain, procurement, finance, marketing, and sales in the decision-making.