Over the last two years, unexpected events have thrown global supply systems into complete disarray. Covid-19, the Ukraine conflict, Brexit, and a container ship stuck in the Suez Canal have created supply shortages on everything from computer chips to lumber - with no signs of stopping in the near term. Every day, there are news stories of choked ports, increased freight, and scarcity of materials that have further deepened the gap between supply and demand. As a result, customer habits have altered indefinitely, scrambling to stock up and consume more leaving chronic shortages.
In a study conducted in 2020 by the Institute for Supply Management, almost 75% of the 628 businesses surveyed had experienced supply chain disruptions. In this same survey, 57% of respondents said they were facing longer lead times for orders with suppliers in China.
Companies looking to make their supply chains more resilient either reallocated supply or built their own warehouses to increase capacity, but neither bridged the gap between demand and supply. Both options exacerbate the problem by increasing costs and lead time.
Revenue Management / Pricing can prove to be a crucial step in absorbing the imbalance between supply and demand when faced with inventory challenges, versus investing in production assets which will also drive up costs and increase lead time. Unlike building factories and ramping up employment, prices can be changed immediately. Likewise, as demand and supply fluctuate, the price can be adjusted, unlike the new production line you just put in.
Take the example of American Airlines and PeopleExpress. In the mid-1980s PeopleExpress began operations in Newark, New Jersey, with fares that were 50 to 80 percent less expensive than those offered by other carriers. Other airlines initially ignored PeopleExpress because they were not interested in the low-cost sector. PeopleExpress, on the other hand, was flying 40 planes by 1983, with load factors of over 74%. American Airlines came up with an effective revenue management solution, rather than lowering the price of all of its seats, on flights with a high likelihood of empty seats, American reduced its price to levels comparable to or cheaper than PeopleExpress. This strategy allowed American to attract customers who valued low prices while retaining revenue from those willing to pay more. PeopleExpress eventually collapsed as more carriers followed American Airlines’ route. America Airlines succeeded because it used differential pricing to drive demand in the area of surplus supply and optimize profit.
In the case of insufficient supplies, revenue growth management can be leveraged to manage demand and maximize profits as well.
- Increase price to capitalize on excess demand: You may have previously encountered difficulties passing on price increases to customers and been compelled to compromise or even reverse price changes. Given the current economy and labor shortages, suppliers are raising prices by double digits; unlike in the past, customers will not be surprised when you come to them with changes in price.
- Rationalize your offer portfolio to consolidate volume into the most profitable offers: Usually companies get into the trap of endlessly expanding the portfolio as incremental offers are equated to incremental sales. When facing shortages due to demand, streamlining your portfolio and helping your back end achieve economies of scale can help you actually increase volume. When looking at which offers to cut, focus on the easy ones first (low volume & low profit).
- Prioritize and target the most profitable customer segments: Akin to trimming your product portfolio, each company has marginal customers. High cost to service and low value (if any value at all). This is the perfect time to choose to de-emphasize or walk away from less desirable customer segments to help the organization drive margin and ensure supply goes to higher-value customers.
- Rollback on promotions and seasonal discounts while the supply is deficient: There is no need to spend money incenting customers to buy products/services that you cannot even supply. Take the opportunity to capitalize on your full list prices.
Experts estimate that many of the factors contributing to supply chain disruptions will remain well into 2023. Revenue management can effectively solve the ongoing problems with the supply chain, increasing profit, stabilizing the demand, reducing lead time, and satisfying end-users/ stakeholders.
Traditionally, companies react to shortfalls in supply with increasing labor, inventory, and ramping up production. A near-term, effective solution that is often overlooked is reviewing the current pricing strategy and revamping it to accommodate the heightened demand. Our team at Revenue Management Labs can help you set up an optimal pricing strategy and helps you manage your dynamic supply challenges.
ABOUT THE AUTHOR Avy Punwasee is a Partner at Revenue Management Labs. Revenue Management Labs help companies develop and execute practical solutions to maximize long-term revenue and profitability. Connect with Avy at [email protected]