March 17, 2015
With the recent drop in worldwide oil prices, many chemical companies are beginning to enjoy a drop in the price of their oil-derived raw materials. The good news: this creates a variable margin expansion or increased profits for these companies. The bad news: their customers know their costs are likely falling and are not shy about demanding that price decreases be passed along to them. U.S. natural gas prices have also begun dropping, though not as dramatically, creating more customer demand for price relief. Chemical companies are torn between enjoying the higher profits and reacting to the customer’s potentially reasonable request for price relief. What’s a business to do?
At the core of good pricing is fair treatment of the customer base and trust with the market. On one hand, passing along price decreases may appear to be the best move for long-term customer loyalty and/or growth with your customers. On the other hand, good pricing also means that you capture your fair share of the value you deliver relative to competitors. You do not want to inadvertently pass along more price relief or pass it along any faster than is fair to you. The fact is that you may NOT need to (nor should you) drop prices just because oil and energy prices have fallen. You must do a deep evaluation of your market and competitive dynamics as well as your cost structure to decide on the best appropriate course of action.
The Situation: Oil prices have been quite volatile for the past decade. In 2005, oil prices began rising from historically low prices of $50 per barrel or less to unprecedented prices over $100 per barrel. The norm for oil prices is now considered to be closer to $100 per barrel, so the short term oil price drop during the 2009 recession and the potentially longer drop now is a drop from perceived norms. When oil prices rose dramatically in the 2005 – 2008 timeframe, these higher prices moved down the value chain and chemical companies faced significant cost pressures. Many chemical companies raised their prices, multiple times, in the name of higher oil and energy prices. This correlation could be seen, with a time lag, in the producer price index for chemical and industrial sectors. Chemical industry customers learned to anticipate price increases following oil and energy price increases. So, it is no surprise that many are insisting on a price drop now.
The Challenge: Should chemical companies drop prices to their customer base, as a result of falling oil and energy prices? If so, how do they determine when and to what extent they should reduce price? How do they make these decisions in a way that optimizes their profits while maintaining long-term customer loyalty? How do you establish a systematic approach to manage these cyclical and volatile market conditions?
Key Decision Factors: There are many key factors that must be taken into account to decide the best course of action. These include:
- Are my raw materials derived from oil-based products or natural gas based products? Is it the same for all my assets in each region of the world?
- Are my raw material costs dropping? On which products? From which assets or regions of the world?
- Are my competitors facing the same cost changes? Are their manufacturing sites and/or import/export behaviors more or less affected?
- What has been my price increase practices and messages to the industry in the past? Have all my customers fully accepted my past price increases?
- Do I have any fair rationale for holding, or even increasing prices, at this time? Do my competitors?
Assuming your analysis indicates you should consider dropping prices, how should you do this in a way that 1) minimizes the amount you should drop, 2) lengthens the time before you drop and 3) increases your success of recapturing a higher price once oil prices begin to rise again.
To learn how best to analyze your situation and set a well-thought-out price plan, join me and Mitch Lee, Business Consultant at Vendavo, for a free webinar on April 1 at 12pm EDT / 9am PDT.