In 2016 we saw several examples of companies raising prices rapidly and causing an uproar in the process. Classpass canceled their subscription to unlimited boutique fitness classes, What The Hell Is Going On With Classpass?. Also Mylan, Valeant, and Turing were all in the news for substantially raising the prices of popular drugs. In fact, they were all called to testify before Congress and were scolded for their actions. Their customers are and have been actively looking for alternatives. These few examples do not mean you should forego price increases or be timid about them; but they do mean you should be thoughtful in the process. Make sure your pricing strategy is multi-dimensional and includes steps to limit your risks when raising prices.
The first step in setting defendable price increases is to avoid having across-the-board common price increases. No matter what price increase percentage you pick, you run the risk of being too high for certain products, and you will definitely miss opportunities on other products. Other elements to consider include:
- How critical is the product to your customers’ business? For mission critical items, customers are less likely to switch to new unproven suppliers and they may tolerate slightly higher increases.
- This answer could be different for each customer segment
- How much of your customers’ total budget is consumed by the product? Your customers will be much more sensitive to price increases on products that comprise a large percentage of your budget. Higher price increases will elicit more negative reactions.
- On the other hand, there is not much incentive for customers to look for alternatives to products that make up a small portion of their budget, and they will be less sensitive to price changes
- What is the price/value relationship of your product compared to competitors, i.e., where is it on the Value Equivalence Line? If your product delivers 20% greater value than competitors, is it priced 20% higher?
- If your price/value relationship is low, you can raise prices more aggressively. Conversely, if that relationship is already too high, increasing the price further could anger your customers
- How many competitors and available substitutes exist for the product? Customers will be more sensitive to price changes on commodity-like products with many competitors and substitutes.
- For more specialized products with few substitutes, customers will tolerate somewhat greater price changes
- How elastic have the purchases of the products been? If customers have historically been inelastic (price increases did not reduce volume), you can be a little bolder with your price increases.
- Be more cautious increasing prices where customers have a history of voting with their feet
Absent from the list above is the change in the cost to produce your product or service, because cost should not be the driver of prices. Having said that, there is no doubt that when customers know your costs are increasing, they are more tolerant of price changes. However, customers care more about how much they have to pay compared to the value they will receive; and those factors will have a much greater impact on their price sensitivity.
If you consider the dimensions above, you will be well on your way to setting product-specific price increases that enable you to capture more margin without too much risk. The last step is to communicate your price changes effectively. That discussion should always emphasize what you do for your customers and how that provides value to them. Be honest and direct about the price changes, and don’t apologize for them. If your prices are really aligned with value, the customers will accept them.
Make sure you give your customers a reasonable amount of notice. Nobody likes surprises, and an adequate notice period let’s your customers plan for the impact. It will also help your customers to offer alternatives. De-scoped products that offer a lower price, rebates for significant volume increases, incentives to order in larger quantities, and product/service bundles can help customers reduce the impact of price increases.
Although we have seen plenty of examples of companies angering their customers with price increases, that should not be the norm. It is clear that huge price increases can cause a backlash, but strategic price increases can improve your profitability without creating customer problems. Be thoughtful and vary your price changes according to the products and circumstances to maximize your upside and minimize your risks.