Passing Along a Price Increase

Unfortunately, there's no simple answer to this question.

Nobody likes a price increase. I've already examined some of the tactics for defending a price increase in articles like A Guide to Price Increase Letters, but explaining a price increase is a very different matter than deciding whether or not to increase prices in the first place.

From a strategic point of view, you'll need to balance the benefit of increased per-unit revenue with the risk that your shoppers will either go elsewhere or decide to avoid purchasing your class of goods altogether.

Here are a couple of questions to consider as you weigh your options:

How price sensitive are your customers?

Let's face it. Some customers pinch pennies and don't want to spend a penny more than they must. Others are less focused on price - there are a variety of reasons for this, ranging from sociological to economic.

The key is to understand your shoppers' intents. The more weight that they put upon your pricing, the more difficult it will be to raise your prices. Think back to past conversations with your buyers:

• How early in discussions were your prices brought up?
• How much time did you spend talking about pricing?
• How much energy did you expend defending what you charge?

If your existing customer base cares about price above all else, you may need to focus upon changing either its mindset or its composition before implementing significant price increases.

Oh, and don't just ask customers point blank. Such methods for analyzing pricing are fraught with danger.

What will your competitors do?

Your customers are not charities. They typically buy from you because you offer a product they want at a price they are willing to pay.

While many business owners often fail to realize it, offerings are rarely considered in a vacuum. Businesses have competitors, each with its own pricing scheme. If your competitors are preparing to raise their prices, you may be able to join them without having to worry. Your increased pricing will be viewed in the context of broader shifts in the marketplace.

Of course, depending upon the economics of your sector, it may make sense to keep your prices low (or even drop them) in order to gain significant market share. Price-conscious shoppers may see unchanged prices as a real bargain, should all other suppliers raise their costs simultaneously.

Are you willing and able to take risks?

When you raise prices, somewhere between 0% and 100% of your existing customer base will stop buying from you. Although there are always exceptions, the general rule is that the more one charges for a given product, the fewer customers he will be able to attract. So the question is, "how much of your customer base are you willing to risk?"

For some businesses, the answer is none.

Vendors with little in the bank to weather the storm may not be able to take on the risk of alienating a single customer. Sure, keeping prices constant in the face of rising costs may lead to financial ruin in the long run, but firms with few dollars in reserve may have little choice.

Even firms flush with cash may find it in their interest to keep their prices low. Firms that sell suites of products may find it worthwhile to maintain the prices of loss leaders. One can look to Las Vegas casinos to see this concept in action. Managers comp high-rollers left and right. Do you think that a gaming establishment's managers care if they lose money on food when such freebies attract gamblers who lose money by the boatload?

Do you have a strong reputation?

I've mentioned this fact before, but I don't like to buy products from Amazon - even when their prices are the lowest around. In short, I believe that the firm is fundamentally untrustworthy and that what they send isn't guaranteed to be what I order. In other words, when I spend my money, I am willing to spend more to buy from firms that I can trust.

No matter the industry (but especially those involving safety or frequent litigation), buyers tend to be willing to spend higher sums of money in exchange for risk reduction. If your business can demonstrate that it is fundamentally more worthy of trust than other firms, you will be able to raise your prices with reduced fear of a customer revolt.

Are there discoverable substitutes?

If, due to your possession of intellectual property, economies of scale, or other unique factors, you are the only firm that can solve your customers' problems, you can probably raise your prices quite a bit without causing significant damage to your bottom line.

The problem that many managers have is that they severely underestimate the availability of substitutes in their markets. Sometimes substitutes look similar, but sometimes they take on very different appearances. A train company may believe that there are no substitutes for its cargo delivery services, only to realize far too late that trucks, aircraft, ships, and bicycles exist.

The easier it is for customers to identify and transact with firms offering these alternatives, the more likely that they will leave you when price increases are introduced.

Of course, if your product is fundamentally superior in a way that is important to your buyers, these effects will be lessened. A person who needs a package delivered across vast distances in a hurry would always select air transport over any alternative. Transporting the good by ocean vessel or train would simply prove far too slow for his needs. This reasoning assumes, of course, that the customer understands the relative speeds of transportation options. Many buyers are not as well-informed as one might think.

Are you able to make trade-offs?

Far too many firms see their products as fixed in terms of quality. If the costs of your inputs are increasing, perhaps you can increase the products' quality to lessen the pain of a price increase. Many consumers won't begrudge a firm for charging more when the quality of its products has also increased.

Asian automobile firms demonstrated this lesson brilliantly in the late 1980s. Although early models were inexpensive, quality standards were nothing to write home about. As the manufacturers were able to build better vehicles, they were able to raise their prices accordingly.

Are you a vendor to a monposony?

The fewer buyers you have, the less power you have to increase your prices. When a buyer knows that his purchases make up a large portion of your income, he can pressure you to keep your prices low. He knows that you'll have little choice, because, if you don't agree to his terms, you'll lose a large portion of your income.

Is there lock-in?

There may be reasons why even customers who are furious over price increases nevertheless decide to go along with them. Welcome to the world of economic lock-in.

Consider the case of Southwest Airlines, a carrier that flies only one model of plane - the Boeing 737. The firm gains several important strategic advantages from this focus upon standardization:

• Its pilots only have to be trained and certified on a single model
• Its mechanics only need one set of maintenance procedures
• Its scheduling and resource allocation systems have fewer constraints

In short, standardizing its fleet on the Boeing 737 has resulted in simplification of management and versatility of operations. The firm can deal with change better and keep costs lower than other comparably sized airlines.

The advantages are not without a cost, however. When Southwest needs to augment its fleet, it will be strongly incentivized to buy more 737s. Similar offerings from Boeing competitor Airbus might be significantly cheaper, of higher quality, and more efficient. Nevertheless, Southwest is locked into its current path. Any deviation from its 737 strategy would complicate its internal systems and chip away at its strategic advantages.

Conclusion

Although we've covered a number of questions that you should be asking yourself when you consider a price increase, we've actually skipped over one of the most interesting questions entirely.

It's clear that you are thinking of the situation from the point of view of a vendor, but that's only half of the story. You're also a buyer of inputs. Why do you assume that you must accept the price increase from your supplier in the first place? The very questions that you can ask to evaluate your own ability to raise prices can be used to evaluate your supplier's ability as well.

It may be that you can re-negotiate the proposed price increase to zero - or even below the rates that you're paying today. Even if your particular supplier stands firm on its prices, you might be able to source your inputs from a different vendor who is more than willing to meet your demands for price concessions.

Remember that a price is nothing more than an offer - one that, as a potential buyer, you're always free to reject or attempt to negotiate.

Questions come from readers like you. If you'd like your questions answered, send them my way.