Is It Time to Raise Prices?

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Simmons acted immediately. Fire Eye's prices, he decided, would go up 25% across the board. Had he done more research -- say, conducting an in-depth value calculation akin to what Cenedella did at TheLadders.com -- he might have selected a gutsier number. But 25% was the most his nerves could take. "I didn't want to alienate myself from my customers," Simmons says. "And I thought it was a fair increase." His heart pounding, he began meeting with clients to break the news. He explained his company's situation. He argued that he could be a stronger vendor if he could invest in his infrastructure and hire new, experienced staffers. He also said he'd understand if clients wanted to take their business elsewhere. Simmons had made his play. How would his customers react?

Determining your new, higher price is one thing. Actually selling it to customers is something else. Simmons's approach -- simply explaining the situation -- is among the most effective. "People are actually very sensitive to what they think something costs to make," says Gourville. When costs increase, and a company cites that as a reason to justify a price hike, few customers react badly. Indeed, just as people appreciate a fair deal for themselves, they also tend to understand that a company has to stay in business as well.

Some customers may even urge you to raise prices: "We want you to be around."

In some cases, customers may even urge you to raise prices. That's what happened to Henk Keukenkamp, CEO of Scope It, a software company in El Dorado Hills, Calif. In 2003, Keukenkamp pegged the price of his project-costing software to that of a similar product offered by Microsoft: $795 per user, per year. When no one balked at the figure, he boosted it to $995. Even then, he found customers were shocked at the low price -- so shocked that Keukenkamp began to feel foolish. "We thought the value we were providing was comparable to Microsoft," he says. "We were wrong. Our customers thought our value was nothing like Microsoft." A pricing theorist would call this a case of misperceived reference price. Finally, Keukenkamp recalls, a customer took him aside and said, "Look, $995 isn't very expensive. How are you going to make any money? We want you to be around to handle updates." Over the next 12 months, Keukenkamp raised the price of a license to $2,295 a year. "I still think we can push it higher," he says.

Keukenkamp's customers had a powerful motivation to keep him in business -- they wanted him around to service the software. It's an enviable situation. But even if you're not as fortunate as Keukenkamp, you can still raise prices. You just have to do a better job explaining the reasons for the move. "It makes sense to try to justify why your prices are what they are," says Gourville. "It's better than having consumers feel like they're getting ripped off." And it's not necessary to raise prices across the board, all at once. Sometimes, a wise step is to test out new prices with small samplings of your customers.

If you don't trust your communication skills -- or if you're reluctant to confront clients directly -- you can slide a price hike in through the back door. One way is to eliminate discounts or change your terms and conditions. "People are more sensitive to list price than to discount terms," says Robert Dolan. Eliminating a discount of, say, 2% to clients who pay within 30 days, for example, is much easier to sell than a 2% increase in prices. (See "Do You Offer Discounts?" page 76.) Or, conversely, you can raise prices but offer discounts to your most important customers.

You can also stop the gravy train and begin charging for add-on services you currently provide gratis. Another option is to keep prices constant but reduce the amount of product or service you're providing. If you're smart about it, according to Dolan, many customers won't notice the difference. Dogfish Head, for example, sells some of its beer in four-packs, rather than six-packs, which boost the price per bottle. Price hikes also can be masked by bundling an array of products or services together. Studies have shown that people think they're getting a better deal when they cannot determine the costs of the individual items they're purchasing.

Just keep in mind that psychology can also work against you. "People are going to use your past price as a reference point," says Dolan. There are two ways around this. You can convince customers that the new, higher price is accompanied by greater value. Or you can "destroy the reference point," Dolan says -- through, say, a redesign or relaunch. If that's not possible, introducing "premium" versions of your service can help raise reference prices across the board. Every time Calagione releases a new product, for example, he charges more than he has in the past, a move that increases Dogfish Head's average selling price while adding to his customers' reference prices.

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