Pricing is always important for any business, but in these hard economic times the role of pricing is crucial for a company to succeed or simply survive. In 2009, as home foreclosures, bank failures, and layoffs mounted, consumer spending habits changed to reflect the increasingly bleak economic climate. Large swathes of firms reacted by lowering prices. Amidst the sea of discounting, however, some companies, such as Abercrombie and Fitch, sought to maintain prices. Perhaps surprisingly, Starbucks recently chose to raise prices on its premium offerings, while simultaneously lowering the prices of it low-end products. What is the right strategy to survive and ultimately profit from a recession? We sat down with Ranjit (Jit) Singh from Deloitte to help understand how companies can approach pricing strategy in tough economic times.

As companies consider pricing strategy changes, it’s not enough to react to the economy in general but rather to how the economy affects the spending habits at a group and individual level. Obviously it is imperative for B2C companies to keep their fingers on the pulse of the end consumer. Knowing the role of the consumer is also vital for B2B companies in determining an appropriate pricing strategy because in the end, as Mr. Singh points out, “all B2B producers are essentially B2B2C companies.” In a recession consumer spending habits change and perceptions of value are altered. Significant drops in personal wealth due to falling home and stock prices, a depressed job market, and a tightening of credit increase precautionary savings and force many consumers to cut back and look for lower cost alternatives.

But should recession-induced changes in consumer behavior permanently alter a company’s pricing strategy? That depends in part on how much of this shift in consumer behavior is permanent. Some believe that shifts in demand will persist due to the “schizophrenic consumer,” the consumer that radically changes his or her spending habits. Mr. Singh disagrees. “Personally I don’t believe that. I think that this will last for a certain time. People have very short memories and Americans are apt to save their money for some period of time and then go right back to their spending ways.”

The expectation of an eventual rebound in consumer spending might suggest that a sound recession pricing strategy would be to lower prices temporarily while demand is weak, and then raise prices as American consumerism returns. But how much should a company reduce price in the short run? And how successful are companies likely to be at convincing customers to pay higher prices once their appetite for spending returns?

Mr. Singh advises that it is important for businesses to stay out of the “discounting trap.” The fact that a recession is taking place should not mean automatic price breaks for customers. Knowing the customer and the end consumer is critical when determining how and how much, if anything, a firm should cede on price.

One of the main challenges when it comes to pricing in tough economic times is that companies want to avoid overreacting and lowering prices too much. “All the companies want to be responsive without being overly responsive. The biggest fear that companies have is: ‘I am willing to make a decision on price where it will help me maintain a good customer or capture initial market share.’ However their fear is that they are going to lower price in a place where they didn’t have to do that for either of those two means: where they already were the preferred place to go for the customer or were charging the right price. “

While companies that have lowered prices during a recession might like to raise prices once economic conditions improve, this is much easier said than done. Especially in manufacturing sectors; a lower price is close to a permanent move. Gas stations are somewhat of an anomaly in that “they seem to be able to easily raise and lower prices as they see fit.” For most companies, the reality is that customers come to expect lower prices as the new norm. As Mr. Singh explains, companies need to understand that “if [they] ever put out a price that’s down there, [they’re] going to be expected to live with that price in the future.”

So why would Starbucks want to both raise and lower prices at the same time? At the low-end, Mr. Singh believes the price decrease reflects Starbucks’ desire “to fight over price buyers” that might defect to competitors like McDonald’s or Dunkin Donuts. Reducing prices also helps to counter the perception that Starbucks is expensive. Drinking a coffee at Starbucks, however, with its baristas, cushy couches and armchairs, “is just a different experience” compared to a McDonald’s.

Raising prices on high-end products may reflect an attempt to maintain the overall margins needed to support this experience. Of course, the higher prices on premium products could instead reflect underlying cost increases that Starbucks was able to pass on to its least price sensitive consumers. Alternatively, the new prices could be related to the introduction of Starbuck’s new line of instant coffees, which was launched widely in September. Revisiting the pricing of all existing products is advisable when making product line changes. See this article for another take on the price changes.

Unfortunately there is no simple answer to the question of how a company should change pricing strategy in the face of a recession. Pricing is difficult enough in a growing economy but there are additional complexities when consumers aren’t spending as heavily. Opportunities to profit and gain market share while competitors are obsessed with cost reductions abound, but finding and capitalizing on those opportunities require bold and brave thinking. Mr. Singh mentioned an interesting article from NPR about finding market share opportunities in a recession. A business that pays close attention to consumers, however, and is strategic about setting their prices can find those opportunities and be more successful for it.

- Adam Crossman, M.B.A. Candidate, Class of 2010