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STREET SMARTS

Dealing With Cost Hikes

Lots of people will tell you now is the best time to raise prices. Don't follow them!

Norm Brodsky is a veteran entrepreneur.

People often ask me what it takes to be an entrepreneur. The most important quality, I tell them, is resilience—the ability to bounce back from failures and learn from mistakes. But another quality is almost as important: a contrarian streak. Most successful entrepreneurs I know are constitutionally incapable of going along with the crowd. When everybody is doing something one way, they automatically start looking for another. They can't help themselves. It's in their blood.

I've been thinking about this lately because of all the articles I've been seeing (including an article in the June Inc.) suggesting that now is the best time in years to raise prices. In my document storage business, I've concluded the opposite. I believe that now is the best time in years not to raise prices, or rather not to pass along cost increases to customers. Why? Because that's what everybody is doing, and you can make a statement, build customer loyalty, and lay the groundwork for future price increases by handling the situation differently.

I hasten to add that I'm not talking about regular price increases here. I believe that you should increase prices every year or whenever a contract comes up for renewal, depending on how your industry works. (See 'The Case for Higher Prices,' May 2000.) Even if the increases are small, it's important to get them. Over time, costs always go up. I'd rather raise prices a little every year or with every new contract than be forced to demand a big increase down the road.

These days, however, we're dealing with unusual circumstances: huge cost increases in several areas. To begin with, skyrocketing fuel costs have hit my company hard because we have our own truck fleet and do lots of pickups and deliveries. Meanwhile, thanks largely to China's economic boom, the cost of steel has soared. That's a problem for us because we buy hundreds of steel racks every year for holding boxes. And, of course, we also face the continuing explosion of health care costs, which have risen annually at double-digit rates for as long as I can remember.

When costs rise as much they have over the past year or two, profit margins inevitably fall. Different people will suggest different ways to deal with that. A bean counter will say you should respond by cutting in other places, which usually means shifting the burden onto other people, especially your employees. A pricing consultant will advise you to raise prices. When you have a hammer, as they say, everything looks like a nail. But entrepreneurs look for opportunities amid problems—and try to avoid doing anything that will hurt or alienate the two groups of people they most depend upon, namely, their employees and customers.

Let me explain how we've handled the situation. First, we recognized that we faced not one problem—rising costs—but three problems, each requiring a different response. The health insurance cost problem was not the same as the fuel cost problem or the steel cost problem, and it would be a mistake to try to solve all three in one fell swoop by jacking up our prices. If we did, we'd succeed only in giving our customers a major incentive to look for another supplier. In any case, we couldn't do it without violating the spirit of the five-year contracts that we, like other records storage companies, have with almost all of our customers.

The contracts haven't stopped our competitors, however. Most of them have added a fuel surcharge to their bills—which has presented us with a great opportunity. By not adding a fuel surcharge, we can separate ourselves from the pack, gaining a powerful sales tool in the process. When we compete with other records storage companies for a new account, we can tell the prospect, 'They're good companies, but they've all added a fuel surcharge. We found other ways to deal with the problem. When we say the price is fixed for five years, we mean it, and you can count on it.'

In fact, that pitch wound up getting us several new accounts. Our competitors' customers were furious to discover that the surcharge they'd been forced to pay could have been averted if the other companies had done what we did. Yes, the higher fuel prices hurt our margins, but the new accounts contributed a substantial number of dollars to our bottom line, thereby cushioning the blow. We also used the surcharge issue to build loyalty among our customers, which we believe will pay dividends in the future. When a contract comes up for renewal, our competitors might offer a lower price, but we can point out what they did during the fuel crisis. We can say, 'The next time there's a crisis, who would you rather be with, them or us?'

The problem of rising health insurance costs raises a different set of issues because it affects the most important part of our business—our people. Employees already pay 20% of the cost of the insurance and thus feel the effect of annual increases directly. We don't want them to have to pay more if it can be avoided. At first, that seemed to rule out the most obvious response: increasing deductibles. But when we looked into the savings we'd get, we realized that the higher deductibles would allow us to reduce our health insurance costs even if we reimbursed our employees for whatever extra they had to pay. We could put a $500 deductible on hospital visits, for example, and reimburse employees for that amount, and we'd come out ahead even if a third of our work force went to the hospital in any given year, which would never happen. We also figured out that we'd save money by putting a $100 deductible on prescription medicines and reimbursing employees. As a result, we're paying the same amount for health insurance today that we paid two years ago—a savings of about 20% over where we were headed. Although about a quarter of those savings have gone to reimburse people for deductibles, we're still spending thousands of dollars less than we would have if we'd done nothing—and we've done it without burdening our employees. Granted, we have to do a bit more bookkeeping than before, but the savings more than make up for it.

The steel cost problem required another approach. We buy steel racks every seven months or so, and we finance the purchases. We realized that, because we have very good credit, we could save a bundle by refinancing our racks through a bank rather than a leasing company, which traditionally charges 3% or 4% more. In addition, we got to thinking about the independent contractor we'd hired to do the layout, buy the racks, and arrange to put them up. She was essentially a coordinator, but did we really need one? What if we bought our own racks and hired our own installation crew? We might whack 10% or 15% off the total cost.

Naturally, the contractor wasn't happy when we told her that we wanted to deal directly with the subcontractor she used to do the installation. 'I have a contract with them,' she said. 'They can't work for you.'

'Yes, they can,' I said. 'You can waive that provision of your contract. If you don't, we'll go somewhere else to buy our racks.'

By getting rid of the middleperson, we're now paying close to what we paid before the price of steel began to climb—a savings of about 25%.

She gave in, and we continued to let her handle the purchase of our racks for a while. We went slowly because we had to learn how to manage the process ourselves. We also had to replace some of the old steel suppliers, which would sell to us only through an intermediary. A couple of months ago, we finally began buying our racks directly from the manufacturer. By getting rid of the middleperson, we're now paying close to what we paid before the price of steel began to climb—a savings of about 25%—and we've done it without adding any employees. Do we have more work to do and aggravation to put up with because we've brought the coordinating in-house? Sure, but cutting costs always involves a little pain. Cutting profits would hurt a lot more.

Then again, we'll never get back all of the profit we lost because of the price increases. Fuel and steel prices may come down a bit, but not all the way. Health insurance will keep going up. We'll be feeling the effects on our bottom line for quite a while. And that's important to understand. When prices rise as much as they have in the past couple of years, you're almost certainly going to have to absorb some of the increases, at least in the short term. The best you can do is to mitigate the impact, preferably with minimal harm to your customers and employees, and then try to rebuild your margins over time through regular price increases and increased efficiency.

To be sure, my methods of mitigating the impact may not work in your business, but what's important is the mindset, not the particular means you use to recoup some of your losses. You need to think like an entrepreneur, not like a consultant or an accountant. You need to look for opportunities in the problems and find innovative solutions that don't turn your employees or your customers against you.

In the end, of course, you may decide that you have no choice but to raise prices. If so, I'd advise you to warn customers about the increase in advance. Go to them and say, 'All of my competitors have raised their prices. I've been trying to hold the line, but I simply can't afford to do that anymore. My new customers are going to pay the full freight. You're different. You and I have been together a long time. I'd like you to help me with this increase. I'll eat part of it, but I think it would be only fair for you to eat part as well. What do you say?'

Some customers may leave you, but you would have lost them anyway. Other customers, the best ones, will appreciate your honesty and your courtesy. Those are the relationships that you don't want to jeopardize under any circumstances.

Norm Brodsky is a veteran entrepreneur whose six businesses include a three-time Inc. 500 company. His co-author is editor-at-large Bo Burlingham.

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Last updated: Aug 1, 2005

NORM BRODSKY | Columnist

Street Smarts columnist and senior contributing editor Norm Brodsky is a veteran entrepreneur who has founded and expanded six businesses.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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