Most of us would agree that Warren Buffet has figured it out. Here is what he has to say about price increases: “The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.”
Here is why price increases are that powerful:
- A 2% price increase boosts your profit by 10% (assuming a 20% margin and constant volumes)
- Most prices can be changed immediately
- Contrary to cost cutting, price increases require no investment and involve little resources
However, most price increases fail. Within the building materials industry, realized increases are 68% below their target. For example, a 5% target gets converted into a 1.6% increase only. Admittedly, even if anchoring high is on every “How to…?” blog, these numbers are shocking. It doesn’t have to be that way.
We have looked at what price increase champions do differently and classified their best-practices into 8 areas.
- Create a clear vision for your sales team: At the end of the sales meeting the VP says, “You need to raise your prices by 5%.” Don’t be that VP. Because it won’t work. Rather understand how much better your product offering is compared to last year. Maybe you have improved customer service or expanded your product portfolio. Don’t just ask just for higher prices. Make sure you understand the change in your value proposition.
- Provide a price increase range for your sales team: A price increase campaign is not an all or nothing game. Rather, develop an escalation process that requires approvals. For example: If the old price was $100 and the new price is $105. A price below $103 needs to be approved by regional management and a price below $101 by VP.
- Provide implementation support tools for your sales team: Develop a list of concessions that you can offer while still sticking to the price increase rate. Think extended payment terms, delayed implementation of the increase, free shipping etc.
- Differentiate price increases between customers and product categories: Segment your products and customers by elasticity. A 10% price increase on a slow mover will barely be noticed and on items with low competitive intensity your customers will have little opportunities to switch. Take advantage of that.
- Consider a surcharge approach instead of a price raise: If you take a look at your last rental car bill, you will probably see a daily rate of $30-$40. However, the final bill was over $100. Do we need to say more?
- Consider non-contracted business only: Special conditions, fixed terms, key account pricing, and net price agreements are just some examples for categories that prevent increases. It is not unusual that only 75% of your business is eligible for price increases. That means, if you would like to see a 2% effect in your P&L, you have to achieve a 3% raise within you eligible business.
- Integrate the increase into your compensation plan: Measure the success rate of price increases and grant special bonuses as an on-top incentive. This will put additional emphasis on the increase campaign without having to re-define the existing compensation scheme.
- Communicate a story to your customer: In accordance with that, create KPIs to prove the added value for your customers. Maybe your lead time has improved from 2 weeks to 1 week. That creates a competitive advantage for your customers and improves their +5%. Once your customers see the added value for them, a price increase will seem just fair.