Charging ahead | Four factors to consider before you raise prices
âAdvice Squadâ is written by members of the Maine chapter of the Association for Consulting Expertise, a trade organization of 88 consultants around the state. This issue's column is written by Alison Hinson, owner of Alison Hinson MBA LLC, a business and personal finance consulting firm in Yarmouth.
With several difficult years behind us, indications are that the economy is slowly getting better. That begs the question: Is it time to raise prices? After trying to stay afloat and keep sales as strong as possible, you may be ready to reassess how you, your customers and your competitors will react to a price increase. But first, consider the following business drivers:
Financial
How will a price increase affect the profitability of your business? Understand how an increase will affect both your top and bottom lines. Analyze the potential impact of each percentage increase and you'll get a good read on the bottom-line impact of your decision.
Model how much existing business you could lose before your price increase has a negative impact. Let's say you assume a 5% increase in price would result in an additional $100,000 of revenue, given no attrition of existing customers. What happens if your two largest customers decide to take their business elsewhere? How much of an impact would this have on both your revenue and net income? Always model the potential downside effects of a price increase as well as the potential upsides.
Competition
Since your competitors' prices may affect your own pricing decisions, be aware of who your competitors are and what they are charging for comparable products and services. This can help you position your own offerings in the marketplace. Any competitive edge you have can support a price increase, even if the differentiation is only a perception due to effective marketing. For instance, think about buying a bottle of Clorox bleach versus a bottle of store brand bleach. While the contents of both are probably the same, Clorox can charge 18% more thanks to its brand and advertising.
Can't figure out how your competitors can run a business selling at a much lower price than you? Sometimes the answer is that they are not running a sustainable business. Pricing a product below cost in order to âmake it up on volumeâ usually leads to a larger loss - the more products you sell, the more money you lose.
A cleaning company I worked with submitted a bid to clean a building, but the owner of the building had gotten a bid for about 60% of that price from another company. My client was baffled as to how a competitor could underbid by so much, especially since my client's profit margin was relatively low. While we couldn't determine the exact expense structure behind the competitor's low bid, we suspected that the business didn't have insurance or bonding for its employees. So my client chose to emphasize its professionalism (insurance, bonding, average length of service, standardized training and strong hiring practices including background checks).
Emotional issues
One of the best indicators of whether you are ready to raise prices is your reaction when your biggest customer calls to say, âI noticed that your prices increased recently.â It will determine whether you can truly stand behind a price increase or whether you will revert to your old pricing.
When a Maine-based personal products company raised prices by 5%, its largest customer called and mentioned the increase. The owner simply acknowledged that prices had gone up, then asked for the order. There was no defense of the price increase. The customer placed the order at the higher price and continues to do business with the firm.
Understanding the financial data behind your price increase can help you adjust to it. The cleaning company stood firm during the bid process because it understood the bottom-line impact of any change in proposed pricing. Work through the numbers so you are confident about where you stand and how you justify the increase in your prices.
Industry
Sometimes regulatory or industry changes result in increased expenses, which you need to pass along through higher prices. Examples include more frequent mandatory inspections by the state or higher insurance costs. These are instances where you might see an industry-wide price hike because your competitors are dealing with the same situation.
Industries where oil is one of the largest expenses have increased their prices in recent years. From heating oil to recreational airplane rentals, escalating prices reflect worldwide increases in the cost of crude oil, which are passed along to end users.
Keep these business drivers in mind as you consider a price increase. An understanding of the financial, competitive, emotional and industry impacts can shape your decision on whether and how much to change your price structure.
Alison Hinson can be reached at alison@alisonhinsonmba.com. Read more Advice Squad.
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