HOW TO EXECUTE AND COMMUNICATE
A PRICE INCREASE
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
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
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.”
Research reported by Sarah Maxwell in Pricing Strategy & Practice indicates that
customers think prices based on costs are “fair.” This approach makes sense because often customers will be seeing
their costs increase, too, and they may be grappling with the same problem vis-à-vis their clients. Another
expert also suggests that government regulations regulations requiring price changes are always a palatable explanation.
And it won't hurth reminding customers how long it has been since your last increase and how competitive your prices still
will be. Here are some guidelines to consider when communicating a price increase:
- 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.
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
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.
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
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.”