Marketing Insight #002 Input Costs Are Rising Again. Is Your Pricing Keeping Up?
Raising prices isn't the objective. Protecting profitable cash-generating business is.
One number in the latest manufacturing data deserves the attention of every product-based business owner.
77.9.
That's where the Institute for Supply Management's Manufacturing Prices Index landed in September—up sharply from 71.1 in August.
The increase indicates that manufacturers are continuing to experience broad input-cost pressure.
And that creates a management issue much larger than simply deciding whether to raise prices.
T
he more important question is:
Are Your Prices Keeping Up With the Economics of Your Business?
Pricing is sometimes treated as a sales decision.
Costs rise.
Management discusses the increase.
Someone proposes a percentage price adjustment.
Sales communicates it to customers.
Problem solved.
Except it may not be.
A 5% price increase doesn't automatically protect profitability simply because management estimates that "costs went up about 5%."
Different costs move at different rates.
Material costs may increase.
Freight may increase.
Supplier terms may change.
Inventory may become more expensive to carry.
Financing costs may rise.
Customers may demand longer payment terms.
And the amount of working capital required to support the same dollar of sales may increase.
The real issue isn't whether you've raised prices.
It's whether your pricing continues to produce the margin dollars and cash flow required to support the business.
Margin Compression Can Hide Inside Growing Revenue
One of the dangers of a rising-cost environment is that revenue can give management a false sense of progress.
Suppose a business increases prices and reports higher sales.
At first glance, performance appears stronger.
But if input costs are rising faster than selling prices, gross margin can deteriorate even while revenue increases.
The business becomes busier.
Sales increase.
More cash may become tied up in inventory and receivables.
But each dollar of revenue may be producing less economic value.
That's why pricing should never be evaluated solely by asking:
How much did we raise prices?
A better question is:
What happened to our gross profit dollars, gross margin, and cash flow after the price increase?
The Pressure Isn't Necessarily Equal Across Businesses
National statistics are useful warning signals.
They aren't substitutes for understanding your own economics.
Two manufacturers can operate in the same economy and experience very different cost pressures depending on their materials, suppliers, freight requirements, customer mix, purchasing practices, and pricing power.
That makes broad inflation statistics less important than knowing exactly what's happening inside your own business.
Which major inputs are increasing?
Which customers and products are absorbing those increases?
Where are margins compressing?
Which customers are producing attractive revenue but inadequate returns?
And how much additional cash is required to finance higher-cost inventory before the customer ultimately pays?
Those are management questions—not economic-theory questions.
Pricing Has a Cash-Flow Consequence
For a product-based business, pricing decisions don't end on the income statement.
They eventually reach cash flow.
If a company fails to recover meaningful increases in product and operating economics, it may need more sales simply to generate the same gross profit dollars.
More sales may then require more inventory.
More inventory requires cash.
Higher sales may create larger receivables.
Larger receivables require cash.
Suddenly, management is celebrating revenue growth while wondering why the business doesn't feel financially stronger.
The answer may be sitting inside the economics of each sale.
Cash Flow Reality Check
With input-cost pressure elevated, consider discussing these questions:
Which of our significant input costs have changed most during the past three to six months?
Have our selling prices changed enough to protect gross profit dollars and margins?
Which products or customers have experienced the greatest margin compression?
Are higher inventory costs increasing the amount of cash required to support our existing sales?
Are we evaluating pricing based on revenue—or on the profit and cash flow the business ultimately retains?
The objective isn't to raise prices simply because an economic index increased.
The objective is to understand whether the economics of your business have changed—and make informed decisions accordingly.
Don't Manage the Percentage. Manage the Economics.
September's sharp increase in the ISM Prices Index is a warning signal.
It doesn't tell you how much to charge.
It doesn't tell you which customers will accept an increase.
And it doesn't tell you which products remain attractive.
It tells you where management should look.
Inside your margins.
Inside your product economics.
Inside your customer profitability.
And ultimately, inside your cash flow.
Because the purpose of pricing isn't simply to generate more revenue.
It's to ensure that the business is being adequately compensated for the capital, resources, risk, and cash required to serve its customers.
Cash Flow Creates Options™
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