How can you optimize prices in a changing market?

Rather than debating a spreadsheet cell, ask a simpler question: did we get scratched, or are we hemorrhaging? We can’t eliminate uncertainty. You can protect your margin of safety. In a world full of things you can’t control, the goal is to avoid real harm, especially the self-inflicted kind.

You can’t predict every hit the business will take or how it could hurt the company’s future prospects. You can, however, map out what you know, name what you don’t, and then work backwards to engineer “rules of engagement” that account for unknown and sidestep monthly fire drills. Because if you change how you sell every time the market twitches, customers stop trusting the ground under their feet, and eventually they stop showing up.

A good example of defining the rules of engagement in the midst of uncertainty is in the trades. Commodities like lumber vary over time. Outside of spot pricing by distributors, it’s not reasonable to bid jobs or employ contractors without an acknowledgement that the price of lumber at the time it's bought is unknowable. So how do you solve for that? Some formally hedge. Some do pass-through pricing (whatever we pay, you reimburse). And some use termed agreements with a blended rate, acknowledging that, depending on the day of the week, one party may benefit more than another but the work just needs to keep humming. The point of this example is that there are multiple ways to solve for volatility, depending on who holds risk, when, and in exchange for what.

In a broader view, the modern market is also subject to other types of change (that are themselves frequently changing). For example, the cost of getting a potential customer’s attention (ad dollars) has been consistently going up online. That change can cause you to have to raise prices every year to offset it and keep margins consistent or reconsider how you engage customers with an aim to change the trajectory altogether. 

To this end, recurring revenue has become somewhat of a holy grail among investors and operators. Under that concept, you are attempting to change the rules of engagement (assuming a previous operating model) to maximize lifetime value. In some cases, it’s an incredible driver of growth, especially where it lowers the price of entry for the customer, but extends the relationship in such a way that the company ultimately retains a better relationship. But it’s also true that recurring payment structures don’t always make sense, and, when poorly employed, feel like you’re just trying to take advantage of customers.

So there are benefits to considering multiple ways of improving predictability, maximizing relationships built with customers and suppliers alike, and consistently optimizing in ways that allow for something random or unforeseen not to immediately ruin your model. That’s what this section is about.

As a final note, in practice, we’ve seen payment terms be an incredible source of value. Most companies are not banks, and if you’re not a bank, you should be careful not to hold too many IOUs. This is especially true because most unanticipated changes that could shock a market won’t just impact your company. Healthy expectations on payment terms are best set before a new stressor shows up. And pricing confidence erodes quickly when liquidity is tight.