There are compelling reasons for businesses to raise prices right now. First and foremost, costs are up. Wages recently grew at an annualized rate of 7.4%, gas prices jumped by 49.6% in the last year, and inflation rates leaped to 5%. Companies such as Chipotle have recently announced price hikes, and many others are considering doing the same.
But before crafting a generic “we have to raise prices” memo, it is worthwhile for managers to consider the potential downsides as well as alternative strategies.
In an increasingly online world, it can be easy to change prices – just a few keystrokes – and managers often carry over this simplicity to the way that they make pricing decisions. However, correctly making a price increase decision involves a multi-layered consideration of issues.
The most common misconception is that raising prices by the exact amount that your costs have increased ensures that current customers will continue purchasing. Customers may be understanding of your situation, but they have their own problems too. Faced with a barrage of higher prices, some purchases may have to be cut or reduced. My annual week-long beach vacation, for example, has been trimmed to six nights because my favorite resort ratcheted up its prices. Even if competitors are raising prices, this does not mean that customers can afford — or are willing — to pay more. Passing through increased costs does not guarantee a profit.
When it comes to price, customers have the memory of an elephant. If you expect an input cost (or a post-Covid demand) increase to be temporary, exercise caution in raising prices if the intent is to reduce them in the future (when costs or demand decreases). A higher-than-expected price sticks in customers’ minds. They may pay it once, but you don’t want to risk your product being mentally coded as “too expensive” and out of their future consideration. Once an opinion on a price is set in a consumer’s mind — particularly for products that don’t regularly fluctuate in price — it can be challenging to reverse this psychological impression.
Finally, taking into account the feelings and budgets of loyal customers is integral in the price setting process. Brian Treitman, owner of Massachusetts-based BT’s Smokehouse, recently shared this concern: “Believe me, it is the hardest thing ever to make the decision to have to raise prices.”
With these insights in mind, consider the following strategies to implement:
Be mindful of competitors.
If they are raising prices, it’s easier for you to do so too. Don’t forget to evaluate how your customers will react (fully accept increase, stop, or lower purchases) as well as the possibility of maintaining price to generate higher volume (stealing customers from rivals). If the competition holds steady on prices, there is less opportunity for a hike.
Provide an explanation.
To defuse pushback, provide a data-backed narrative on why prices are increasing. Customers are more amenable when they understand why they are being asked to pay more. Common justifications include citing data on cost/CPI increases, noting how long it’s been since the last time the company raised prices, and in the B2B space, highlighting how much a client’s product prices have increased over time.
Lower other costs.
It’s unrealistic for managers to believe that they have carte blanche to pass along any cost increase and that customers will in essence respond “No problem, keep your normal profit and we’ll continue buying the same amount.” Counterbalance increased input costs with savings from elsewhere.
Roll out a “Best” version.
The combination of pent-up demand and stimulus money may increase the receptivity of customers to buying a high-end “Best” version of a product. The upside of offering a premium version can be significant. Experience shows that when companies implement Good-Better-Best strategies, often 30% to 40% of customers choose Best, which is typically priced at 40% to 100% above the current price.
Provide options to retain price sensitive customers.
A price hike may not work for some customers. Instead of writing them off, offer choices to keep them in the family. Examples include a cheaper, stripped-down “Good” version, a lower-priced smaller volume offering, or a protection package that mitigates future price increases.
Reexamine prices individually.
Inevitably, examining a company’s prices leads to discovering that some are too low. Properly pricing these products may reduce the pressure to make an across-the-board increase or take unnecessary risks on other products.
During this time period when “everyone else is doing it,” it is easy to slip into a “let’s raise prices too” mentality. For a cost-driven price increase, there is no guarantee of success. Carefully scrutinizing the potential downsides, re-examining certain prices as well as costs, and providing options can equip your company to successfully navigate today’s cost inflation. More importantly, these actions create a robust pricing strategy foundation that will continue to deliver profits and growth in the future.