Higher & Higher

In recent years, product pricing warranted daily discussions between CFO Alan Hippe and his colleagues at Continental, a €16.6 billion German tyre maker. Today, those conversations are just as likely to be taking place by the hour. Amid rising raw material costs, "pricing is key," Hippe says. "It's a discussion at every board meeting, at every level." Although cutting process costs has offered some respite, the company now has little choice but to share the burden with customers. While in the past it never raised prices more than once a year for any product, that has changed. Its replacement tyre business, for example, has raised prices three times in the US and twice in Europe this year, with further increases likely in 2009.

Continental's experiences speak volumes about the groundswell of change in corporate pricing strategies. Once a sensitive topic that companies broached gingerly for fear of losing valued customers, record-high prices of oil and other commodities have emboldened executives to raise prices more aggressively than ever. In today's tough climate, in fact, it's common for companies to break the taboo of speaking about increases publicly without having to worry about a customer backlash. And, if handled well, a small increase can go a long way towards boosting the bottom line, contends Simon-Kucher & Partners (SKP), a marketing and strategy consultancy. In an analysis of FTSE 100 balance sheets, its consultants reckon these companies could achieve an average profit increase of 14% by raising prices by only 2%.

Yet according to Marco Bertini, a professor of marketing at London Business School, price increases are often primitive and managed in an ad hoc fashion. If companies are trying to find ways to boost their bottom lines, recalibrating the prices of goods and services can make a bigger impact than many companies realise, he contends. That said, "the level of sophistication [in terms of how companies deal with their pricing] is not very high." But a range of CFOs are showing that under their leadership, pricing strategies can be turned into the carefully executed exercises that they should be.

Special Treatment
Consider Ciba Speciality Chemicals. Like other companies, the SFr6.5 billion (€4.2 billion) Swiss company has experienced recently the effects of rising input costs working through its supply chain, including a 50% increase in the price of gas isobutylene, a key ingredient in its antioxidant business. Subsequently, Ciba's profit margin fell to 5.2% in the first half of 2008 from 8.2% in the same period the previous year.

The company has battled to keep production costs flat, absorbing a rise of about 10% in energy bills through practices such as lean manufacturing. It also wants to save up to CHF500m by 2010 through an efficiency programme.

But the way CFO Jürg Fedier sees it, cutting costs isn't enough. "You can save whatever you want, but if you're not able to get some traction from a margin protection point of view or a pricing programme, you're going to be nowhere," he says. "That's a fact of life." To this end, Fedier used a recent earnings call to announce that Ciba had a new, "aggressive attitude" towards pricing. This year, it raised prices on a long list of products, including increases of about 20% for its paper imaging, pigment and additive products.

For a company like Ciba, with almost 10,000 individual products, it's crucial to differentiate price changes for different products. Consultants at SKP point out that prices on niche products, for example, can be increased at a greater proportion relative to input costs with little impact on volumes. On the other hand, large price increases are not advisable for products that can easily be bought from competitors, something that companies understand intuitively but often do little about.

To address this at Ciba, there's a steady flow of information between finance, operations, procurement and sales, analysing costs and prices on a product-by-product basis. "We know at any one time what the potential impact of movements in raw material prices is going to be on the end-product price," Fedier says. "Then, depending on the strategy for that particular product, you determine to what extent you're able to pass [cost increases] on in price." A price hike is not always a foregone conclusion, Fedier notes, citing stiff competition from China which forced its latex business to cut prices despite soaring costs. "The perfect idea would always be to recover whatever rises are coming through raw materials," he says. "But the market may not allow you to do that."

Customers need to be taken into consideration when pricing products. (See "What's the Difference?" at the end of this article.) Understanding high-value customers and their willingness to swallow price increases is critical to a strategy's success. That's more than clear at airlines such as Ryanair, a €2.7 billion Irish budget carrier which has built its name on low fares. CFO Howard Millar calls the company's customers "very price sensitive," a fact of life that "you ignore at your peril."

As he explains, Ryanair knows the triggers that allows it to jack up its prices, keeping fares low until two weeks before a flight, when time-pressed travellers have fewer options, so are willing to pay more. As CEO Michael O'Leary has joked, the best yields are derived from passengers travelling to funerals, "because they generally don't get a lot of notice, they book late and they have to travel at certain times."

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