I read an article in the Wall Street Journal Friday, New Worry for CEOs: Rising Costs From Metals to Meat, that discussed recent increases in inflation. Curiously, the article subtitle was Companies could be forced to raise prices or eat the additional expense. I think they have it wrong. Companies should look at this as an opportunity to raise prices and correct underpriced products and customers. Having the right pricing strategies for inflationary markets will help.
The first element of your strategy should be, don’t be timid. Although customers don’t want to receive price increases, they expect to receive them from time to time. They expect those increases even more so when inflation is higher. The Unemployment Rate has dropped to 4.1%, a 17-year low; and the Fed has announced more interest rate increases are planned. Customers can see these economic forces at work and they will not be surprised as their suppliers raise prices. FedEx and UPS both increased their prices by an average of 4.9% recently, and those increases are higher than inflation.
Next, remember not all products and customers are the same, so don’t give them all the same increase. The WSJ article above cited food inflation of more than 3%, and steel inflation of 7.8%. A flat price increase might lower your margins on some products and raise them on others. More important than your cost changes are the values of your products and services versus your customers’ next best alternative. That means you should re-assess your value proposition vis-à-vis your competitors – for each product.
It is easy for the price/value relationship to get out of whack over time as you and your competitors battle in the market. So, take the time to measure the differences between your products and your competitors, and quantify how those differences affect your customers’ businesses. A great time to correct any prices that are not aligned with value is when you are changing prices generally.
Remember that customers tend to be less price-sensitive on specialized and exclusive products/services than they are on commodities. In this sense, I am defining commodities as those that have readily available perfect substitutes. You will have more freedom to increase prices above inflationary levels with specialized products than you will with commodities, so set your increases accordingly.
Another important element is to evaluate how critical your offerings are to your customers. The more money your customers spend on a given product or service, the more an increase will impact them, so they will scrutinize it more. On the other hand, customers will pay a greater premium for products and services that exactly meet their specs when those items are critical to their own operations. That means if your customers spend a lot with you for products that are overhead to them, they will be price-sensitive. If those products or services help them generate revenue, even though they are a big part of the customer spend, they will be less inclined to take risks with their providers.
A related factor to consider is how easy it will be for your customers to switch to an alternative product or supplier. There is always a switching cost anytime a customer changes to a new product/service or vendor. When your products or services are highly integrated with your customers, the cost to switch is high. On the other hand, if your relationship is simply transactional, switching costs are lower. Make sure you appropriately assess this when determining customer-specific price changes. When switching costs are higher, you can implement somewhat higher price increases. That said, don’t put your customers in a position where they feel you have taken advantage of them. It will come back to haunt you.
That leads to my final point - avoid shocks. Although your customers expect price increases, if you raise their price too much at once, they will get angry. And, when they get angry, they will look for alternatives. They may find that your price is still better than their next best alternative, but they can retain that anger for a long time.
I started this by encouraging you to not be timid. Don’t be afraid to raise your prices more than inflation when appropriate. If you identify and quantify all the factors I cited, you will get varying indicators of how bold you can be on your price increases. Your job becomes like that of a chef or a winemaker. You need to blend those factors into a meal or a wine that has the right balance. Don’t rush it. Don’t take shortcuts. If you do it right, your customers will stay happy and your profits will improve.