Business Survival in a Volatile Economic Environment
Pricing to Survive - Using Tariffs with Added 'Insurance' Features
The following article briefly explains the importance of tariff structures when you supply a 'commoditised' product or service. Designing tariffs with added 'insurance' features could be the only way to ensure long-term survival. This could apply when your confidence in a customer's demand forecast is low or unproven or where you are unable to secure an exclusive supply arrangement.
Outsourced Services & Commoditised Supply Arrangements
Ensuring business viability when you supply ‘commoditised’ services or a homogenous product like power and water is an uphill challenge in an era when customers forever search for better prices and lower costs. Today, most customers are unwilling to enter exclusive supply arrangements, particularly ones that extend over many years. Getting the price right 'first-time' is often essential.
Contract negotiations are increasingly ‘price sensitive’ in a better informed world. Brand loyalty carries minimal value as customers strive to cut costs. Even strategic partnerships with key suppliers are increasingly taken as a ‘free’ given by large customers. In any case, the risks of contravening competition law, has reduced opportunities to restrict competition through strategic partnerships, especially in competitive tendering processes. Using onerous criteria designed to disqualify some types of supplier may be challenged in the courts if the criteria used is difficult to justify. This makes price the key influencer when customers choose a supplier today.
The Importance of Predicting Demand Accurately
During my earlier career in the power, water and telecoms sectors a major challenge faced by Sales when pitching for new business was to understand the most probable level of demand the customer would bring for our product. Customers often talked-up predictions of demand in the hope of securing better prices. Estimating demand reliably and accurately was critical to securing a positive (rather than negative) contribution to fixed overheads.
When selling an otherwise indistinguishable product like electricity or telecoms, differentiation largely boiled down to price with perhaps confidence in the provider’s ability to give uninterrupted supply a secondary consideration. Informed buyers aren't swayed by marketing hyperbole when making a decision today. All other things being equal, price is often the main consideration.
This poses a real dilemma for suppliers lacking scale, such as start-ups or those who carry a high level of fixed costs in a low margin business. They cannot afford to commit to growth or think about future plans without some level of certainty about earnings. You can't 'bank on' customer demand being at least X when you approach your suppliers or the bank to negotiate favourable terms. Survival demands a level of self-administered ‘protection’.
What form can this protection take?
Some businesses rely on invoice-factoring to stay afloat. But even this doesn’t address uncertainty in demand, which directly impacts the amount you can invoice.
Businesses need to build in some level of ‘certainty’ about the level of earnings they make despite uncertain levels of orders actually placed in a given period. Developing appropriate tariff structures can help provide a level of certainty needed for businesses to invest and grow. Of course, this won’t eliminate the risks of over-trading or poor financial control, but it can move a business from ‘survival’ mode to ‘growth’.
The following flowchart may help identify situations where a different tariff structure is needed. Even if the business ends up securing fewer customers, its ability to plan for the future will be greatly enhanced as will its chances of long-term survival in a volatile and uncertain world.
