In stable environments, if I make a pricing mistake it's not very important. But in today's environment, it's a matter of life and death. You'd better get your pricing right.
In a crisis, consumers generally start to rein in their spending and save more - just in case. But how should companies then market their goods and services in a downturn?
In a new working paper by INSEAD professors ‘Paddy' V. Padmanabhan and Pushan Dutt called ‘When to push the panic button?', the authors drill down on the impact of economic crises on consumer behaviour in different categories of products and services in developing, as well as developed countries.
Padmanabhan, a professor of marketing, says companies shouldn't just focus on industry metrics as that would give a ‘very incomplete picture of what's going on.'
Market share is not a good indicator as the money that consumers once spent on your products and services isn't necessarily going to your competitor.
So from a marketing perspective one of the things that firms have to do in a crisis situation is start getting a better handle of not their share of the market but their share of the wallet and start figuring out what is the consumer's wallet, what are they spending on, in the crisis how is the share of wallet now changing across brands, across categories, he says. And that will give you a sense of how you might go about figuring out what you should be doing in a crisis.
The paper looks at how the consumer's dollars are spent in four categories: durable goods or big ticket items such as cars, TV sets and photography equipment; non-durable items - food, electricity, gas and so on; semi-durables; and services such as education, health and finance.
Within those categories, spending patterns can shift - with expenditure on cars predictably falling, while spending on bicycles increases in terms of durable goods. In the case of non-durables, spending on food increases, whereas spending on electricity and gas falls.
Consumption of durables or expenditure on durables contract significantly and they contract the most, Padmanabhan says, whereas consumption of non-food (items) contracts, but contracts a lot less.
And there aren't just differences in consumption patterns between categories. These also vary across different types of economy, depending on whether it's a developing economy or developed.
If you are in a developing economy, what you see as the durable goods share, actually goes down and goes down remarkably, Padmanabhan says. Non-durables share actually increases and that's what happens in a developing economy. And the idea would be things like food are a necessity. People still have to spend and they will do that. And so the share relative to your income actually goes up.
What is interesting is when you look at developed economies, food is a necessity but what the data show is that services are a necessity in those markets as well. So what you do find is share of durable goods going down, share of non-durables going up, but share of services also goes up. So in that sense, food or non-durables would be a necessity in a developing economy, but non-durables and services are necessities in the developed economy.
It's a complex picture, but one which companies need to get to grips with. Dutt, an assistant professor of economics at INSEAD, says per capita consumption takes a smaller hit in developed countries, whereas in developing countries it's much larger. Plus the hit that it takes persists for much longer periods of time for developing countries as compared to developed countries.
One of the reasons for this is that credit markets in developed countries are much better developed, whereas they are thin or missing in developing countries. So therefore when a crisis hits, consumers actually lose access to financing and borrowing. So what they do is they really cut back on their consumption expenditures because they're also not aware of how long the crisis is going to last.
The bottom line: companies need to figure out how badly they're going to be hit, both in terms of the sectors they're operating in, and the local context in terms of the country they're in. If you look at the share of the wallet pattern in Hungary, it's going to look very different to the share of wallet pattern in, say, Vietnam or India, Padmanabhan says.
For global companies operating in both developing and developed economies, this will create an added level of complexity. If yours is a global firm, you cannot have a one-size-fits-all approach to managing the crisis, Padmanabhan says. You have to understand the category you're in, you have to understand the country you're in and realise your strategies for coping with the crisis. You do need to reflect on this divergence.
Price wars should be avoided and managers should take care when trying to figure out what is happening to sales as they combat the impact of a crisis on sales. If you just pay attention to income or pricing metrics and try to make sense of what's happening to your sales, you're going to make mistakes, because what we show is the crisis ... has an independent impact, Padmanabhan says.
And if you don't correct for that accordingly, firms could make very, very bad decisions, he told INSEAD Knowledge. You might create a price war where you don't need to.
If you are a firm, you're trying to understand within the crisis situation, when my sales are plummeting, to what extent should I adjust my prices, Dutt adds. So I have to make a pricing decision, and right now it's extremely important because things are extremely volatile. In stable environments, if I make a pricing mistake it's not very important. But in today's environment, it's a matter of life and death. You'd better get your pricing right.
You may also have to take consumption smoothing effects into account - this is when consumers try to balance spending and saving - even though the paper didn't actually find much evidence for consumption smoothing. In a crisis situation, prices are the easiest thing to change, Padmanabhan says. Companies typically respond by reacting with prices when you have a crisis situation. But what this shows is in fact you have to be very, very careful in using prices. You have to figure out what's going on and how people are smoothing the consumption.
Don't just look at price elasticity. Don't just look at income elasticity, he says. Understand that there's also a crisis component to sales and you need to be able to put all these three things together. If you don't, you can draw the wrong inferences.
While the paper actually focuses on the impact of currency crises on consumer behaviour, the authors believe the research is still valid in today's banking or credit crisis. Currency crises are ‘easier to measure,' as you just need access to exchange rate data, while a banking crisis in ‘slightly more tricky' to measure as you'd need to look at bank grants and at what the Federal Reserve is doing. However, you can think of both of these as really negative shocks to a particular country, Dutt says. Both of them have been shown to have a similar impact on GDP growth rates.