The costs for raw materials are up.
Health insurance costs continue to climb.
Labor is in short supply which typically means wages will go up.
As of the US Job Openings and Labor Turnover Summary report released on June 5th, 2018, there are now more jobs available than people looking for work. According to the US Bureau of Economic Analysis, wages and salaries grew 4.56% from April 2017 to April 2018.
Is it time to raise prices?
I had a great discussion with a client recently on this topic.
What became obvious as we talked, is the importance to first be clear on the goals of price increases.
The goals of any price hike are to maintain or improve the following:
Your net profit margin (pre-tax net income divided by revenue), despite cost increases
Your total net profit in dollars
The answer is straightforward if you are in a competitive market, you routinely provide quotes or proposals, and you rarely lose the order. Under these circumstances, you should raise prices unless you have a strategic plan to grab market share.
However, if you are losing with enough frequency to know that you are not grossly underpricing the market, then the answer is more complicated.
As an aside, if you do not measure your win/loss ratio with consistency, now is the time to start.
Four Essential Questions To Ask Before Raising Prices
Consider these questions together, not separately. The answers will paint a picture of whether a company will be successful in executing a price increase. It is essential to plan price increases with care, and well in advance.
- What cost increases have you experienced since your last price increase, and what do you expect to encounter during the next calendar year?
- What is the state of demand?
- What trends do you see in pricing?
- What is the state of competition for your products and services?
What are the historical and anticipated cost increases?
On the one hand, customers do not care about your costs. They hire you to deliver a complete product or service. They depend on you to innovate on costs and efficiency. It is not their job; it is yours.
On the other hand, the right customers want their suppliers to be successful over the long term. A situation where the customer always wins and the supplier (you) always loses is not a sustainable strategy for the long run. You will go out of business.
Good customers have both perspectives.
Doing the research on cost increases since your last price increase and anticipating future cost increases has multiple benefits.
It helps you determine the amount of the price increase you need to maintain your net profit margin (pre-tax net income divided by revenue). Remember: maintaining or increasing your profit margin is the goal of the price increase.
Forecasting future cost increases helps keep you from doing too many price increases.
Understanding past and likely future cost increases help you communicate and justify price increases for employees. Many salespeople and other employees feel guilty about raising prices and making a profit.
Identifying the sources of cost increases help you develop the narrative for explaining the price increase to your customers.
What is the state of demand?
This question stems from the bedrock of economics. When demand increases and supply remains constant, prices can rise. Naturally, it follows that this works in reverse as well.
If demand is healthy; if customers are desperate to get products or services to meet their commitments, then you will have more opportunities to increase prices. What choice do they have?
Furthermore, if your operations are close to capacity due to strong demand, then raising prices is a way to ensure maximum profitability. In this situation, you are allowing the laws of supply and demand to work in your favor. Failing to raise prices would be foolish in many cases.
What trends do you see in pricing in your industry?
In some industries, companies have standard pricing. If this is the case, answering this question is relatively straightforward: what price increases have you seen from your competitors?
In other industries, pricing is customized based on specific requirements, like in construction. If that is the case, you may have to infer pricing trends based on what you have learned in competitive bidding situations: do prices seem to be increasing or do they seem to be stable?
Often, merely talking to people in the industry is an easy way to gain insight into what competitors are doing related to pricing.
What is the state of competition?
Competition creates the supply side of the supply and demand equation.
Healthy competition is fantastic. It forces efficiency and drives the creation of greater value for the customer. Competition keeps businesses from becoming lazy with productivity, quality, innovation, or service.
For most companies, supply is a function of two simple questions:
- How easy it is for new competitors to enter the market at current or lower pricing?
- How easy it is for existing competitors to expand their capacity at current pricing?
Because of the uncertainty and time commitment of working with a new supplier, I find that many customers will stay with their current suppliers if the price increases are modest. From a theoretical perspective, this outcome is a reward for your company’s brand authority or reputation.
In any price increase scenario, however, there is always a chance of customer attrition. Fortunately, there are steps that you can take to ensure that the risk remains minimal.
Next, take a look at a few of these critical strategies for your business to help price increases go smoothly.