Labor shortages. Rising wages. Products out of stock. Broken supply chains. This is the world on inflation. As the IMF issues strong warnings on global inflation risks, business should be contemplating when and how to raise prices. Has your business raised prices yet? Let's walk through the important considerations for businesses contemplating a price increase.
Why raise prices now?
The world is at the center of a perfect inflation storm - rising demand and shrinking supply. In the span of just 6 months, we are seeing:
- Pent up demand released as economies re-open.
- Supply shortages due to factory shutdowns during the pandemic.
- Massive increases to money supply due to Federal Reserve asset purchasing programs.
- Three rounds of federal stimulus payments to citizens and businesses.
To top it off, congress is debating an additional 3 trillion dollars' worth of stimulus measures. The result is lots of people trying to buy very few products, creating shortages in everything from cars to chicken nugget dipping sauce.
There are only three ways three ways a business can cope with inflation:
- Raise prices
- Lower costs (through automation, offshoring, etc.)
- Accept lower profits
Lowering costs requires big investment in automation, training, or new business structures. Accepting lower profits may work in the short term but is unsustainable in the long term.
Therefore, amongst the three options, raising prices is the most financial compelling. Yet companies are reluctant to do so. Why?
Reasons not to raise prices.
Most businesses will go through extreme measures to delay or avoid raising prices. There are several reasons for this:
Many B2B service and product companies are locked into long-term contracts with their customers. This is especially common when it is a small business serving a large corporate customer (or the government.) These same small businesses are often unable to lock their own suppliers into long-term contracts (lacking the size to negotiate,) so they get stuck in between rising costs and flat prices.
In hyper-competitive markets with ample supply, raising prices may drive away customers. This is common in transportation, hospitality, and commodities. However, if your industry is currently experiencing supply shortages, you are more likely to lose market share from product shortages than from price increases. In that case, you are better off governing demand through price increases.
Changing prices comes with significant one-time expenses, called menu costs. All organizations face some form of menu costs such as updating sales documents, websites, POS systems, etc.
The #1 reason small businesses do not raise prices is fear. People are uncomfortable with change, and altering pricing is a big change. Pricing is more than a financial decision: pricing changes your brand, marketing, operations, and sales. It alienates some customers and attracts others. To change pricing is so scary, most businesses will go years between price adjustments.
How price increases impact your business.
Pricing affects nearly every part of your business. Small price increases of less than 5% may not cause much disruption (although these often have a muted or insignificant financial benefit.) But price increases of more than 5% come with a host of impacts on your business:
Your branding shifts to a premium focus.
With higher prices, you signal to the market your goods or services are higher quality than the competition. Your marketing needs to shift to embrace this positioning. You should target customers who expect better products or user experience, tweak your messaging to advertise quality and reliability, or create an image of prestige for people who use your product or services.
You lose cheap customers.
Every business has customers who expect a lot but want to pay little. Raising your prices naturally weeds out the cheap customers, saving your customer service and sales team many headaches! The downside is you might also weed out a small business customer you love to work with who now can no longer afford your brand.
Operations shifts from volume-focus to quality-focus.
Low-price businesses are focused on volume and efficiency. High-price businesses are focused on quality, timeliness, and experience. To meet the expectations of your new premium customers, you will need to shift your staff's focus. Invest in training. Spend more time reviewing KPI's like OTD and NPS, less time on utilization and yield. This shift in focus will be easier to do now that your cheap customers have left, freeing up staff time.
Sales targets increase.
With the rise in prices, you need to raise the targets for your sales team. Consider increasing minimum deal size, lowering commission rates, or raising base targets.
Employee skill and compensation increases.
All these changes require a more highly skilled employee who will require higher compensation. But this was an inevitability - inflation is driving up employee compensation anyway. By raising prices, you are pivoting your business to weather the wage increases.
Should you raise your prices?
The right pricing strategy will depend on your business and your industry. I recommend performing a full competitive pricing analysis to determine the best course of action. If you do not have the time or resources for a full pricing analysis, here's a rule of thumb:
If there are shortages in your industry, you should raise prices.
That statement applies to well over half the economy right now, so odds are now is the right time to raise prices.
After successfully implementing a price increase, your business will have higher margins, more free cash, fewer annoying customers, less shortages, and more satisfied employees. Sounds great, right? In truth it is a challenging maneuver which requires careful coordination by your whole team. That is why most small business owners are afraid to do it.
If you are unsure whether your business should raise prices, you should:
- Schedule a meeting with your fractional CFO to forecast the impact of a price increase.
- Discuss price increases with your sales and marketing team to estimate market response.
- Collaborate with operations to understand how they would re-orient around a premium offering.
- Meet with your management team and/or board of directors to gather consensus.