Although the move smacks of desperation, GM is not the only firm hoping that discounting can help it weather a sluggish global economy. On August 20th eBay, an online-auction site, said it would reduce the fees it charges sellers who post goods for sale on its site at a fixed price. The temptation in a downturn is to let prices slide to protect or increase market share. However, this approach can backfire if it triggers a price-cutting spiral. Moreover, managers often overestimate the extra sales that lower prices generate, so companies may be left worse off than before the cuts. That may help explain why a number of firms have been raising their prices, not cutting thema trend that has contributed to a resurgence of inflation.
In many cases, these increases are chiefly a response to rising prices for raw materials and energy, which have also stoked inflation and made price-setting even trickier than usual. Take BASF, a German chemicals giant renowned for its pricing prowess. It has rigorous planning that helps its businesses decide what to charge customers. In some product lines the firm has reacted quickly to higher prices for oil and other inputs: after raising the price of its Styrolux plastic in Europe in June, it did so again in July, as input costs rose more steeply than expected. But with other product lines, BASFs hands have been tied by customer deals that limit its ability to pass on higher costs in the short term.
Kimberly-Clark, an American consumer-goods company, has also been wrong-footed. In July it admitted that it had underestimated its 2008 costs and said it would raise prices for the second time this year. For its part Procter & Gamble, one of Kimberly-Clarks rivals, has announced price rises of 4-6% across its product range for its new fiscal year, to help offset an expected $3 billion increase in commodity costs.
Bosses may see such price increases as a quick fix. But deciding what to charge requires careful analysis of such things as break-even points and price elasticities of demandhow buying habits change after a price rise or a discount. Real-world testing can help. McDonalds is charging more for its popular double cheeseburger (which normally costs $1) in some American restaurants than others, to gauge customers tolerance of a permanent price rise that would help offset the higher cost of ingredients. It is also experimenting with holding the price, but reducing the amount of cheese or beef in the burger.
When raising prices, firms also need to consider how rivals will react. It helps when all companies in an industry are desperate for revenue. Airlines have followed one another by adding surcharges for fuel, baggage and other services. It also helps when a price increase is triggered by a strong industry leader. Nitto Denko, a Japanese firm that makes optical film for liquid-crystal displays, has helped defuse a price war by publicly signalling that it will focus on profitability rather than building market share.
Of course, deciding on a price increase is one thing; ensuring it happens is another. Efforts to raise sticker prices sometimes come unstuck because salesmen give discounts to favourite customers, or because managers make temporary exceptions to the new rule. Once you start with the first discount, the second one is just round the corner, warns Stephan Butscher of Simon-Kucher & Partners, a consultancy that specialises in pricing. To see where that can lead, look no further than the pickle GM has now found itself in.
The Economist Newspaper Limited 2008