Inflation rates provide a reasonable yardstick for measuring buyers’ purchasing power. By comparing income growth with inflation, we can determine how well buyers are able to keep up with rising product prices. But, there is something that is perhaps much more important in our ever-expanding (or, nowadays, contracting) economy that is unmeasured. Just comparing inflation with income growth does not allow us to see how well consumers are keeping up with rising numbers of products. And this product proliferation not only impacts consumers’ purchasing power, it has deep impacts all the way up the supply chain to the purchasing power of retailers, distributors, and ultimately manufacturers.
If there is a lot more to purchase, or a lot more stuff that can be incorporated into the products you make, each party in this supply chain needs to have the financial ability to entertain such a large set of choices. Looking at income growth and inflation alone conceals the true nature of spending power. It is not as much about whether or not our incomes today are keeping up with the prices of things we bought yesterday. It’s about whether or not our incomes are keeping up with the additional things we can buy. It’s about whether or not manufacturers’ incomes can keep pace with the exploding set of ingredients they can choose to put into their products, and whether distributors can cost-effectively stock and sell an ever-widening mix of products, and so forth. The rate at which these new things emerge is faster than the rate at which incomes grow – and therein lays the crux of the pricing problem (firm birth data obtained from U.S. Census Bureau and Income data obtained from U.S. Bureau of Labor Statistics):
Even though inflation may be growing at a rate that is in line with wage growth, the burgeoning number of items available to consumers (and perhaps even critical to consumers – just a decade ago there was no anti-bacterial lotion, and yet now you can’t walk 10 feet in a hospital without walking past an anti-bacterial gel dispenser) makes consumers have less spending power.
This spending power is a 2-dimenional thing, but we have tended to focus on only one of those dimensions – i.e., we’ve levied most of our focus on inflation versus income growth, and have not focused as much on product variety versus income growth. Today, there are many more things to buy both directly and indirectly (for instance, when we purchase a car today that contains twice as many parts as a car from 20 years ago, we are indirectly purchasing “more things”) and this breadth of choice bites deeply into our spending power.
It is not just whether or not the prices of things that we bought 20 years ago have grown in pace with our incomes, its whether or not the sheer number of products and the total global value of those products have kept pace with the total global value of our incomes. And by this measure, spending power has failed to keep pace. The obvious response as a seller is to flock to everyday low pricing – but, this “obvious” response actually fails to respond to the right problem (which is one of burgeoning product assortment). Price reductions alone will not bring spending power up to the levels of power we had just a generation ago. And the problem is only going to worsen, for innovation will continue to accelerate and the diversity of goods and services offered in the global economy will continue to mushroom.
So, what’s a pricing manager to do in the face of this shrinking spending power headwind? First and foremost, recognize the strong interplay between your marketing efforts and your pricing. Every dollar invested in marketing will impact the prices that you can charge for every product in every market (or, for B2B vendors, sales & marketing dollars directly impact the prices that you can charge for every product that can be sold to every customer – so, if you have 100,000 customers and 50,000 SKU’s, you have 5 Billion customer-item combinations that you need to understand). Marketing effectiveness and pricing excellence are joined at the hip, which means that marketing managers and pricing managers must couple their decisions optimally. This is especially true now because your marketing voice is drowned out each day by more than 3,000 other voices. The chart below shows the sharp rise in advertising expenditure in the U.S. alone (data obtained from Coen Structured Advertising Dataset):
Secondly, recognize the strong interplay between your product assortment and your pricing. In the face of ever-widening product choices, being able to identify the right bundles of products for the right customers or customer segments is pivotal to combating ever-narrowing spending power. Remember, everyone’s Achilles heel in this race to sell is the explosion of assortment mixes. If the crux of the problem is product assortment, then therein lay the solution. Identifying which products to co-sell with other products, and what price that entire combination should have for every single customer or within any single market is the key to winning this race.