Reasons for increasing prices
Customers and businesses often shy away from the dreaded words ‘price increase’. But as a business owner you shouldn’t be afraid to do what is sometimes necessary. There are many reasons why a business might need to increase prices.
Here are some of the most common reasons for increasing prices:
- To increase profit margins. Perhaps your business is relatively new, and you initially kept prices low to attract customers. But now, you’ve gained some customers and a reputation and it’s the right time to increase prices to get profit margins up high enough so that you can make a decent living.
- Strategy changes. Suppose you've been marketing your business as a value provider, but you'd now like to rebrand to catch higher-end customers. A higher price is critical to gaining acceptance in this premium sector.
- The manufacturer issues a Recommended Retail Price (RRP) increase. While you might not always sell a product at the RRP, if the manufacturer has raised it, chances are good that the market value of the product has increased.
- Increased supply chain costs. Your supplier has raised the price of raw materials or the cost of delivering them to you. You'll need to raise prices to maintain the same profit margin.
- General inflation. If inflation means a rise in payroll or other business costs, you'll have to increase prices to maintain your margins.
- You’ve added new features to your product or service in response to customer demand. Your product or service is now more valuable, and a price increase is in order.
Risk of not increasing prices
Price increases aren't without some risk. However, you may be taking a greater risk by not raising prices. If your costs rise and you fail to increase prices, you risk becoming unprofitable. At the very least, your margins may shrink. If margins shrink, you'll either need to cut costs or sell much more to stay profitable. Selling more may not be viable for some businesses, especially services businesses. After all, your ‘product’ is your time and that’s probably already in short supply.
If you wait too long to increase your prices, you may end up having to make a larger increase. A significant price rise threatens your brand's reputation and customer retention. Customers are better equipped to handle smaller, incremental price increases.
Stages of making a price increase
Businesses that successfully introduce price increases do so in four stages: research, strategy, communication, and measurement.
Research helps inform your pricing decisions. If you've been in business for a while, you have a history of price changes. Looking back on those can help you understand how price hikes have affected your business. Also, make sure you know your current profit margin and what margin you need. An accountant can help you with this.
Customer research can help you understand customer loyalty, resistance to price increases and the demand for your product or service. Also, check the prices your competitors charge for similar products and services.
2. Develop the strategy
Use your research and the reasons for increasing prices to develop a pricing strategy and method that makes sense for your business. Here are some possible strategies and things to consider:
- Simply raise prices without an announcement. Retailers may find that simply issuing new price tags works just fine.
- Make the increase only in specific markets or with new customers. For example, you might keep your founding customers at the old price while raising the price for newer customers.
- Offer perks, such as rewards or loyalty programs, to retain customers after the increase. For example, a massage therapist might offer an option to receive 10% off a third treatment during the same month.
- Raise the prices for everyone, but offer occasional discounts and other deals that bring the prices down to the previous level.
- Raise prices by a certain percentage every year, which may be tied in with inflation or cost of living.
- Raise prices only on certain products. Examples may be products you want to make premium products or your most popular products. A slight price increase on high-volume products can produce a significant revenue increase.
- Keep base prices the same but end discounts, especially for existing customers. Eliminating discounts effectively raises prices without formally doing so.
- Keep the base price the same, but add a surcharge. For example, for customers who want services during peak times.
3. Timing of the increase
Consider the best time to make the increase. While the best time varies with each business, you might consider raising prices:
- after you've just upgraded a product or service or won an award as consumers are more amenable to paying more for a better product or service
- when demand is high - if you're a services business consider raising prices when you're booked up 75% to 80% of the time
4. Communicate the increase
Be transparent and give customers plenty of notice so that they can budget for the increase. Regulations, ethics, or customer satisfaction may require you to notify some customers early of an impending increase, especially in services industries.
Announce the increase gently, using words such as adjustment or update. Give customers both a percentage increase and the actual amount. Communicate it with signs, through emails, and one-on-one. Be sure to contact key customers directly before making a general announcement. If they are upset, talk through what led to your decision.
Remember to highlight the benefits of your product or service and how it adds value. And tell them if the increase is because of increases in your costs, such as labour or supply chain costs. Also, if it’s been awhile since you last increased prices, mention that in your communication.
5. Measure the results
You'll want to measure the results to change course if necessary. Listen carefully to any feedback from customers and respond appropriately. Also, consider surveying customers. Keep your eye on the numbers. If you see sales falling significantly or profitability falling, take time to analyse the situation and consider making adjustments. Accounting software, like Xero, can help you with this analysis through up-to-date accounting reports.
Experiment with pricing
If you have a little time before you have to make the price increase, consider some experimentation to determine the right price and strategy. You could try two different prices to see which provides the most revenue. Offering bundled pricing is another way to experiment. For example, a mobile phone company might offer a phone, case, and screen protectors in a bundle at a discount in one market to see whether the concept will work.
Alternatives to increasing prices
Sometimes a price increase won't work for your product or service and you need to look at other methods. Here are some alternatives to a price increase:
- Add or raise fees. If you've always offered free shipping, consider charging shipping for orders below a certain amount.
- Remove pricing tiers or consolidate them to increase your revenue.
- Reduce stock held to reduce costs. If you have a feel for how much product you need, or know you can receive it quickly, consider reducing the amount you store in your warehouse.
- Negotiate better payment terms with your suppliers. If your business has grown and you've increased your order from your suppliers, you may also be able to negotiate a price discount, depending on your industry.
- Change product size ('shrinkification'). If you've always packaged your cereal in 500g boxes, consider packaging it in 450g boxes for a similar price. This can attract some blowback from customers though, so be prepared!
How to increase prices successfully
Don’t be afraid to make necessary changes to your prices to keep your business running efficiently and profitably. If you do your research, plan a strategy, communicate it well, and measure the results, price increases don’t need to be something you dread.
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.