I have said it and written it repeatedly – customers don’t care about your costs. They care about the value of your price compared to their next best alternative. You can’t set high prices just because your costs are high. That said, if your costs decrease and your customers know it, they will often view the decrease as leverage to request lower prices. Don’t assume you need to grant their wish.
Last week, Pete Coors, Vice Chairman of Molson Coors Brewing Co. wrote an opinion article in the Wall Street Journal, Aluminum Suppliers Kick Our Cans. In the piece, Coors argued that all aluminum suppliers raised prices when the Trump tariffs kicked in, but in May, tariffs were lifted on imports from Canada and Mexico. When tariffs were lifted, 77% of imported aluminum was again tariff free, but the suppliers did not reduce the prices of their aluminum cans. Mr. Coors would like government regulators to force aluminum suppliers to reduce their prices. He is misguided.
All markets have a natural tension between buyers and sellers. Sellers want to sell for as much as they can, and buyers want prices as low as they can get them. Competion, laws against collusion, and the fear of losing a sale help keep prices at an equilibrium. Buyers who are skilled at leveraging that tension are rewarded with lower prices from their suppliers, and they are able to keep their own costs low.
For the past 30 years, manufacturers of an enormous range of products have refined their procurement skills and lowered their costs of supplies by increasing competitive fear. They have done it by finding new suppliers in low-cost countries, implementing sophisticated RFPs, conducting reverse auctions, demanding year-over-year efficiency improvements and price reductions, demanding just-in-time delivery, etc. The manufacurers effectively created price wars in many supply industries. If one supplier’s costs were higher or increased more than competitors, that supplier has typically had to choose between not winning the business or accepting low or negative margins. There are no government regulations forcing buyers to pay their suppliers a constant margin.
When cost increases affect all suppliers in an industry, those suppliers are generally confident they can raise their prices and their competitors will do the same. Especially when margins are thin, suppliers know their competitors do not want to lose money. When all competitors raise prices, there is no advantage for customers to switch suppliers. As an example, when crude oil prices have increased over the years, prices on oil-based products also went up. And, as we saw with aluminum, when new tariffs were placed on products throughout an industry, all suppliers successfully raised their prices.
What about when cost decreases affect all suppliers in an industry? Should the suppliers lower their prices? Not if they can avoid it, but holding their prices steady for very long will require steady nerves and strong negotiation skills.
Mr. Coors states in the article that his company has asked aluminum suppliers to lower prices, but they have “flatly refused.” He even cites some traders have hoarded their supply, artificially keeping market supply low and prices high. That won’t go on forever. Those traders will eventually want to monetize their inventory. Although things have not happened as quickly as he would like, market forces will eventually win.
A standard concept in game theory is the Prisoner’s Dilemma. The idea is it is in the best interests of the participants (the prisoners) to cooperate, because the total overall result is best when they do. However, if one prisoner sells out the other, the prisoner who gets sold out has a worse result, while the prisoner who does the selling has a better result. In a competitive market, if suppliers keep prices high and do not try to take market share from each other with lower prices, the total margin for all suppliers remains high. However, if one supplier lowers prices to win more market share, that supplier’s margin may increase, but total margin for the group of suppliers goes down.
In the aluminum Prisoner’s Dilemma, perhaps the suppliers are all cooperating now and are not selling each other out with low prices. Historically huge companies like Molson Coors have convinced their suppliers that some other competitor is going to lower prices (sell them out); and that has eventually caused all suppliers to crack. I am confident those same market forces and advanced procurement skills still exist, and at least one competitor will start dropping prices to pre-tariff levels. If they are smart, the suppliers will maintain their prices and enjoy decent margins as long as they can.
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