Deciding when to raise your prices … and by how much
A price increase is sometimes unavoidable — and now might be one of those times as many businesses are dealing with cost increases, supply chain bottlenecks, and labor shortages.
The key to implementing a price hike with minimal loss of customers is timing. It’s hard to be the first one in your industry to raise your prices. If others don’t follow suit, your business could be in the embarrassing position of having to rescind price increases and determining other ways to make ends meet. Here are some key considerations when weighing the pros and cons of increasing your prices.
The first step is to gauge customer loyalty. Some companies have built a base of loyal customers who are willing to pay a premium for their brands. Others have a customer base that’s made up of bargain hunters who would be willing to switch brands to save a few dollars.
How do you know how loyal your customers are? Ideally, you’ve been monitoring their purchasing patterns over the years, and watching how they respond if you or a competitor has a “sales event.” Depending on the nature of your business and your ability to monitor customer behavior, you can also gauge loyalty by how long customers have been patronizing your business. If there’s significant customer turnover and you increase prices, your business could be in a vulnerable position.
Another consideration is the nature of what you sell. If it’s a basic necessity and you dominate your market, your customers might have little choice but to accept a price increase. And even if you sell “luxury” products and services, you might also be in a good position to raise prices to the extent that your customers have an abundance of disposable income and aren’t price sensitive. Of course, that wouldn’t hold true for cost-conscious buyers of nonessential products.
Once you’ve laid the groundwork for assessing the likely impact of a price increase, you can move to the next round of analysis by answering these four questions:
- Which products or services should I raise prices on?
- How much should prices increase?
- When should the price increases take effect?
- Should I notify customers about increases, and, if so, how do I explain the increases?
These questions must be considered in light of how much you’re being squeezed in the current business environment. The more urgent the situation, of course, the less flexibility you have.
In deciding which items to raise prices on, consider the potential cash flow impact. The most immediate effects will come from increasing prices on high-volume products. However, if you’re selling some high-volume, low-priced “loss leader” items to draw in customers who’ll also buy more profitable items and that strategy is working, go easy on raising prices on those bargain items. (See “Responsive Pricing” at right.)
Generally, gradual, selective price increases are less noticeable to customers than an across-the-board price increase. But in some cases, a one-time “tear-off-the-Band-Aid-quickly” price hike, not to be repeated in the short term, can make sense if accompanied by an explanation that customers can accept. Alternatively, you can refresh your product or service offerings and then charge a premium for “new-and-improved” versions that cost you about the same as the old ones.
Now or Later
The current attention on inflation and other unfavorable external market conditions may provide a good cover for your business to increase its prices, especially if others in your industry are raising prices, too. By tying your increases to, say, an increase in the consumer price index, or average gas prices, you can help justify a price increase to your customers — and they’ll likely appreciate your transparency.
Your financial advisors can help evaluate where price increases would be most impactful. They can also recommend alternative or supplemental business moves you can make to keep your business secure in these uncertain times.
Every business strives to be customer-centric. But do your prices really reflect customer demand and market conditions? Price should never be a static number. It should evolve with your business.
Your business needs a pricing strategy that considers what customers want and value — and how much money they’re willing to spend. Examples of economical ways smaller businesses can research their customers and competitors include:
It’s also smart to investigate your competitors’ pricing strategies using ethical means. For example, the owner of a restaurant might eat a meal at each of her local competitors to evaluate the menu, decor, and service. Or a manufacturer might visit competitors’ websites and purchase comparable products to evaluate quality, timeliness, and customer service.
Low-cost pricing isn’t the only way to compete — and it can be disastrous for small players in an industry dominated by large conglomerates. Your business can charge higher prices than competitors if customers think your products and services offer enhanced value.
For example, if your target market is more image-conscious than budget-conscious, you can set a premium price to differentiate your offerings. You’ll probably sell fewer units than your low-cost competitors but earn a higher margin on each unit sold. Premium prices also work for novel or exclusive products that are currently available from few competitors.
Conversely, you may decide to set a low price, at least temporarily, to drive competitors out of the market and build market share — or to survive adverse market conditions. Being a low-cost leader enables your business to capture market share and possibly lower costs through economies of scale, but you’ll earn a lower margin on each unit sold.
Similarly, you may discount some loss leader products to draw in buyers and establish brand loyalty in the hope that customers will subsequently buy complementary products and services at higher margins. You also may decide to offer discounts when seasonal demand is low or when you want to get rid of less popular models to lower inventory carrying costs.
If your company engages in one-to-one selling, such as a car dealership, management should compare pricing trends among salespeople, as well as changes in gross margins over time. In these types of sales environments, it’s critical for salespeople to understand how to price products to different categories within your target market without losing money or tripping any legal minefields, such as discrimination claims.
One Size Doesn’t Fit All
Whether you’re pricing a new product for the first time or reviewing your existing pricing strategy, your financial and legal advisors can help ensure all the bases are covered.
About the Author:
Steve Pierson provides clients with a wide array of technical accounting, tax, financial, estate and succession planning, employee benefits, and international tax planning expertise, as well as merger and acquisition transaction guidance. Pierson is an Executive Vice-President and Shareholder of Seldon Fox.