The Risk Associated with Raising Prices

Sooner or later, every marketer deals with the need to raise prices. The task should not be taken lightly. The goal of raising prices, of course, is to generate incremental revenue from those accepting the price increase, which exceeds losses from customer attrition and/or a lower level of sales from remaining customers and/or a reduced level of sales via new customer acquisition. However, the net result could be reduced revenues, fewer customers and perhaps loss of good will even among those customers who remain. Dreadful—on all three counts.

Most pricing consultants, therefore, strongly recommend testing the impact of a price increase. Some suggest using public relations tools to signal the impending increase and see what customers and competitors do. Others advise trying the increase in part of the country, in isolated markets, with some segments, etc., before adopting it everywhere. Some propose marketing research, e.g., conjoint analysis or econometric modeling or proprietary tools that they are happy to provide.

The Opportunity Derived from Raising Prices

Fortunately, most customers are a bit “sticky.” There are business and emotional hassles associated with changing suppliers, e.g., accommodating new people, learning new sys­tems, adapting to new paperwork and procedures, being at the bottom of a learning curve, removal from a comfort zone, etc. Furthermore, research indicates that while price always matters, it rarely is the only thing that matters. So if the price increase is correctly executed, revenues and profits may very well increase.

McKinsey has conducted a frequently quoted analysis of the typical S & P 500 company and concluded that pricing right is the fastest and most effective way to increase profits. They found a 1% price rise, if volumes remained stable, would generate an 8% increase in operating profit. This impact is 50% greater than a 1% drop in variable costs such as materials and direct labor. It is also more than 300% greater than the impact of a 1% increase in volume. (The sword also cuts the other way—a 1% decrease in price brings down operating profits by 8%.)

So how should a marketer go about it? The following sections discuss a variety of pricing strategies and tactical options and conclude with a recommended communications plan.

Several Attractive Pricing Strategies

• Deloitte Consulting recommends doing what they have termed a SKU (stock keeping unit) Velocity Analysis to determine which SKUs account for the major­ity of sales and inventory. The point is to focus the price increases where they will actually do some good. (A deeper level of analysis would look at contribution rather than revenue.) Thus a small change in a high velocity SKU can produce a bigger result than a larger change on many lower velocity SKUs.
• They also recommend examining prices charged for the same SKUs among different segments, termed a Price Band Analysis. The point is to discover and then focus on price changes among those segments not pulling their weight.
• John Hogan and Tom Lucke, of the Strategic Pricing Group, writing for MarketingProfs.com, make a related point. In mature markets, they argue, it may be a better strategy to focus on share of wallet rather than share of market. The intent is to capture more sales from current customers rather than attracting new ones. This use of the pricing tool, by the way, will less likely invoke a significant competitive response.
• All the major price consultancies recommend conducting a Price Waterfall Analysis to determine what the actual “pocket price” is, as in “money in your pocket.” Every seller offers a list price, followed by a series of margin reductions, e.g., order size discount, discount to meet competition, discount for class of trade, annual volume discount, damages and returns, coop advertising, shipping rebates, penalties for labeling, shipping or order entry errors, payment terms and conditions, etc. After all the discounts have been applied, the net price is the pocket price—something far removed from the list price and even removed from the invoice price. If these discounts (termed “sources of leakage”) can be eliminated or reduced, revenues will increase even though the list price does not change.
• A surcharge can be employed to cover a temporary cost increase due to extraordinary circumstances. The basis price stays the same and the surcharge is used to cover the unavoidable cost increase. Again, the list price does not change. The implication is that when things go back to normal, (e.g., fuel costs decline), the surcharge will be dropped. Failure to do so will alienate customers.
  

And here are additional ways to raise prices (adapted from 46 ways to raise prices … without losing sales! (www.RaiseYourPrices.com ) by Marlene Jensen © 2005):

• Psychological pricing suggests that it is often easy to move prices up to the next psychological “barrier.” Thus if the price is $9.00, it might be possible to raise it to $9.99 without difficulty. The key is not adding a digit or changing the leftmost number, e.g., $19.50 can go to $19.99, but not to $20.
• Break out fees formerly included in the price. This is a practical application of psychological pricing. Suppose we sell a newsletter for $199/year delivered. If we want/need to raise prices, we’d have to cross the $200 “barrier” and likely lose sales. So instead we keep the price at $199, but now charge $10 for delivery.
• Not raising all prices the same amount can be productive. Prices for key SKUs are closely watched, but not those for all SKUs. So keep the price increase most modest for the key SKUs and raise it more for those less studied.
• Add a higher priced option even though it will likely sell poorly. Most buyers like to be somewhere in the middle of the price/quality distribution. Quite a few never buy the most expensive of anything; thinking it is just not smart. And many never buy the cheapest either; thinking it’s poor quality. By adding a new “most expensive” option, the new distribution of sales will shift to include greater sales of the formerly most expensive option.
• Bundle the sale with extras or premiums. The intent is to add enough perceived value via the premium that, after the incremental costs of the offer are deducted, net cash from sales is increased and the current product is no longer comparable with competitor products based on price. It’s no longer apples to apples.
• Itemize the components of your bundle. This tactic is designed to increase a product’s perceived value. It’s accomplished by publishing an imputed price for each element of the bundle even though they will never be sold separately. This should increase the perceived value of the whole and make raising its price easier.
• Shrink the offering. The classic method is to keep the price the same, but reduce the volume of the contents, e.g., putting 15 ounces of candy in the bag instead of 16 ounces. The price increase may not be noticed since labels are not well-read. This has been done repeatedly in the food industry—yogurt, candy, coffee, chips. Related is reducing the product’s physical size, e.g., newspaper and magazine pages are smaller, 2 x 4s aren’t 4 inches wide. Similarly, magazine subscription lengths have been reduced; auto lease mileage allowances have declined, etc.
• Increase the quantity in the package. This is not so farfetched as it seems. If the cost of the packaging is significant, selling one package with twice as much in it, for example, can save money over selling the same amount in two packages. (And it will save inventory handling costs, picking and packing costs, etc.)

How Best to Communicate a Price Increase

If you intend to raise prices, it is imperative to communicate the increase to customers in a timely, appropriate manner. Several sources argue that a well-presented explanation of the increase, along with specific evidence regarding why it is necessary, will be posi­tively accepted. For example, “This is being reluctantly done because our fuel expenses for deliveries have increased an average of 68% in the past six months and we can no longer absorb this cost increase by ourselves.”

• The customer must not think the price increase is being initiated solely to increase profits, i.e., padding profit at their expense.

• In addition it is imperative the increase be announced well in advance (at least 30 days) of the time that it goes into effect. This offers customers a last chance to order at the old prices. (As a practical matter, this may lead to forward buying so be prepared for a bump in near term sales that is likely not to be repeated. There are also obvious order fill and inventory considerations here as well.)

• The largest customers must receive a personal (scripted) visit from a sales rep to communicate the price increase and reasons why it needs to be implemented.

• The next largest customers should receive a similar (scripted) phone call from their customer service rep.

• All customers later receive formal, personalized communications via MAIL.
• Email blasts are specifically advised against because they seem impersonal and provide less security.

• The tone is one of confidence and matter-of-factness. We take your business very seriously. Price changes are part of business. Ours is quite justified.

• While what to say is clear, there is no common advice regarding how best to say it. This may be an opportunity to solidify your company’s Brand Personality via creative copy, design, etc. Remember this is another—important—touch-point with customers.

There is one proviso; the price increase must not place you so out of relative position vs. competition that customers are encouraged to also look elsewhere. This requires a com­petitor price check, e.g., look at their websites, check with your sales force, ask customers who are “friends” of the company, etc.

Relatedly, make the price change easy to implement from the customer’s standpoint. If the customer has to do a lot of paper and computer work to implement a price change, s/he might as well look at someone new for whom s/he’ll surely have to do the same thing.

Conclusion

Every marketer will consider raising prices to increase revenues. Doing so, however, should not be undertaken casually as the negative impacts of an error in executing a price increase can be profound. This article presented several strategies and tactics, which have proven successful for others, and discussed how to best communicate a price increase with customers. As with much in marketing, pricing remains more of an art than a science.

Finally, as Gurumurthy and Little (MIT working paper) suggest: “Marketers wishing to increase price, should nibble, not bite.”

Gerald Linda

Glenview, IL

May 2009