If it’s time to make more profit, it’s time to raise your prices. In fact, as good business practice, you should review your pricing every few months. Small but regular price increases are a better story to tell than massive leaps in charges.
If you don’t want to increase the price, you may face one of these choices:
- Exiting unprofitable products and moving your product mix to include more profitable products.
- Looking at different pricing techniques such as adding value to existing products and change their price point.
- Shutting up shop and selling out.
The biggest fear businesses have about increasing their prices is that they worry it will scare off all their customers. This fear paralyses many businesses and stops them from making plain common-sense decisions. It’s true that some customers may leave (and probably a lot less than you think), but the ones that remain will be more profitable.
It’s also true that in some cases increasing prices has the opposite effect. Since people fundamentally believe that you get what you pay for, some businesses generate more business through increasing their pricing because the customer believes they must be better to charge a premium.
If the customer perceives you offer something of value to them, they tend to buy it within a broad price range (with, perhaps, the exception of a genuine commodity product where differentiation is difficult).
If you are too busy and there are too many customers knocking on your door demanding your attention, you’re probably underpricing. Raise them. It has the added benefit of weeding out the price-buyer who is often not worth the effort to deal with.
More than anything else, pricing should be tested. There is no right or wrong answer, and no crystal ball to tell you when pricing is right. You need to know your customer, your competition, and the price sensitivity of the products you sell. But even knowing all these things doesn’t guarantee you’re going to get it right.
Many businesses say that a better gauge of whether pricing is right is the level of whining and complaining a business receives. No whining tends to mean you’re underpricing. Too much whining may indicate overpricing. Tweak the level of whining until your gut reaction says it is about right.
Preparing to Increase Your Prices
There are basically 2 ways in which you can raise your prices – either overtly or in less obvious ways.
METHOD ONE: OVERT PRICE INCREASES
Increasing your pricing overtly essentially means you have simply increased your price from an effective date.
It may be by individual or selected product, or it may by product lines or universally applied across your entire range.
Depending on your business, you may or may not give advance notice to customers of an intended price increase. If your customer doesn’t care about the new charges, or if they are unlikely to know about the old ones, or they are transitory customers with no long-term relationships, it may not be necessary to attract their attention to your revised pricing.
However, if the opposite is true and you have established relationships or contract commitments with customers, you must always notify them in advance of what you plan to do. (If nothing else, this preserves the transparency of your relationship and it has the added benefit of allowing you to reiterate the benefit the customer derives from doing business with you.)
Before you increase prices, you need to prepare your response to price objections.
Why is your price increase justified?
Brainstorm a series of questions and responses with your staff and particularly salespeople. It may be that raw materials or labour costs have increased and you need to pass these costs on. Everyone has a level of expectation that these sorts of cost increases are passed on. Give these responses to all customer-facing staff so they are prepared if customers call to query pricing. The key to this is to use the opportunity to reiterate the benefits the customer derives from using your product.
You can tell customers you prefer to avoid cheap imports because you are more confident in the quality of locally-made products, for example.
If you are reselling someone else’s products or services, try negotiating an extra from the manufacturer that you can bundle with the price rise to sweeten the taste of it with your customers. This may be something like additional or extended warranties, free bonus when the product is purchased at its new price (for a limited time) and so on.
Make sure all your price lists and signage are updated.
Price increases that do not attract attention
METHOD TWO: PRICE INCREASES BY STEALTH
Just as you can increase your prices overtly, you can also do it without attracting attention.
Here are some of the ways you can achieve this:
- Changing the way your product is presented so the price of it becomes hard to compare. Techniques like offering quantity discounts (2 for the price of 1), bundling of complementary products together all serve to make prices difficult to compare since it shifts the customer’s attention to value rather than price.
- Removal of discounts and special offers, forcing the product to be retailed at its full price.
- Changing the terms and conditions of trade (such as reducing the credit terms to improve cashflow).
When is a good time to raise prices?
It’s a good time to raise your prices when the following occurs:
- The demand for your product or service is overwhelming and outstrips your ability to properly service it.
- When you are working many hours, getting exhausted, and still don’t have enough money.
- When other people tell you that you are not charging enough.
- When you need to make a bigger profit.
So when do you do it? Why not raise your prices today?
After all, there is no time like the present.
If your products or services are unique and hard to find, and you have a good reputation for supplying them, you shouldn’t be concerned about increasing your prices.
Many businesses don’t raise their prices, time goes by and their margins squeeze tighter.
Having small but regular price increases is a good business practice.
(This is not to say you should pass on every little price increase that faces your business, you may be able to absorb some of the smaller costs until they become cumulatively big enough to warrant a price increase.)
Why It Might Be Better To Charge More
Let’s imagine that we are Tom Smith’s widget company. We have posted a modest profit and we’re thinking of increasing our prices because we want to build up some cash reserves. Our costs haven’t increased.
Here is the math we need to do:
Each widget has a variable cost of $0.50 each.
The company’s total fixed costs are $100,000.
In the last financial year, Tom Smith made 300,000 widgets that were sold for $1 each – so his revenue was $300,000.
We know that the formula for calculating total costs is as follows:
Total Cost = Fixed Costs + Variable Costs.
From this, we can calculate that Tom Smith’s costs are:
$250,000 = $100,000 + $150,000
What happens if Tom decides he wants to increase his prices by $0.50 cents per widget.
To calculate the effect, Tom needs to do three things.
- First of all he needs to calculate his gross profit margin. This is the amount of revenue left over after variable costs have been met.
- Second he needs to establish demand for the product at its new price by testing its price elasticity. Even if his demand falls, Tom Smith may make a profit since his variable costs will be reduced.
- Third he needs to look at his breakeven analysis to determine how many widgets he needs to sell to make a profit.
CHECKING THE BREAKEVEN ANALYSIS
How many widgets do we need to sell?
To calculate the breakeven, Tom Smith’s fixed costs ($70,000) need to be divided by the contribution each widget sold makes ($0.50). This will give you the breakeven quantity.
In other words: $70,000/$0.50 = 140,000.
If Tom was to increase his price by $0.50, each widget would contribute $1.00 towards fixed costs.
The breakeven quantity for this is as follows:
$70,000/$1.00 = 70,000.
In other words, increasing his price by $0.50 results in halving the number of widgets he needs to product in order to breakeven.
Of course, if he increases his prices, he may not sell as many widgets. Let’s say that instead of selling 300,000 widgets, he sells 270,000 (a drop of 10% in sales volume).
The first thing that would happen is Tom’s variable costs would reduce.
We know that each widget costs $0.50 to make so his revised cost position will be: $235,000 = $100,000 + $135,000 (Total Cost = Fixed Costs + Variable Costs.)
Let’s look at the gross profit margin with the lower sales volume (270,000) at the higher price ($1.50) and lower variable costs.
Despite increasing his prices and reducing sales volume, Tom Smith has been able to maintain his 67% contribution to fixed costs.
Of course, this is a pretend example to illustrate a point.
The moral of this example though is that you should test different price points and be brave enough to experiment.
There are certainly circumstances where you can increase prices and it doesn’t mean you’re heading out of business.
As a final test, Tom Smith could take a look at the price elasticity of widgets and, if this was the real world, he would test the price sensitivity.
To know how to do this, go to How To Test For Price Sensitivity.
READ: More about pricing strategy