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Here’s a thought: charge more! Why price increases are vital to protecting your profits

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Would it surprise you if I said it’s a good idea to Increase your prices to reflect changes in costing, consumer knowledge and a premium value proposition? Profits are only impacted by two things: revenue and expenses.

Revenue is the money coming in. Costs are two things: the costs of goods (COGS) and the business expenses, like payroll and utilities.. The simplest profit formula, as you may know, is sales(gross margin) – cost = profit before tax.

That’s all MBA 101, but let’s break it down a little further.

Your “best price” changes all the time

Yep, I know that seems a lot, but how often do your costs, competitors, or customers’ perceptions vary? – I’ll bet at least one of those changes pretty much each day… And I am also pretty sure, unless you are a fresh food producer selling at the wholesale market, your prices stay the same; probably year in year out?

You can control some of your costs, most of the volumes you buy, AND your price which need to incorporate many variables to safeguard profits. A great way to protect your profit is to hike prices at least once a year. I heard a great tip the other day – Hike prices on your birthday every year – that way you give yourself a nice present.

WARNING: If you want to go broke extra fast ignore how you set prices, simply ‘price everything to sell’ irrespective of what it costs to produce and deliver in your business

But, before you start worrying about losing customers – let’s do some basic math:

If you raise your prices by 10% you need to also have 10% of your customers leave you before the price hike becomes detrimental to your profit.
If you raise your prices by 50% then HALF your customers need to leave you before it becomes detrimental to your bottom line.
If you raise your prices by 2% most likely no-one will object (or even notice)

Remember you can choose who you want as customers. Are the ones who are most price sensitive, and might leave as a result of a price hike, really the ones you want to keep, or are they the type of people that make your job un-enjoyable? If they are the latter perhaps it is best you let them go anyway. Pricing well is a skill, and optimising your pricing almost an art-form.

It is not difficult to build yourself a reasonable price hike, just make sure you cover the Four Cs:

  • Competitors
  • Cost
  • Customers
  • Content

Let’s consider each of these in turn.

Competitors

The simplest, easiest, and therefore generally the least accurate pricing method, involves discovering what your competitors are doing and then setting your price to reflect theirs. This is a DANGEROUS APPROACH as it assumes your costs, and the return you need for your risks, are exactly the same as your competitors….That is really, really unlikely!
Your business; your investment; your risk; your needs; therefore YOUR PRICE!

On the flip side, it is important to understand what your competitors offer for the price their customers pay. The right knowledge enables you to differentiate your value proposition – ideally you will work out a business model that enables you to deliver to your customers for slightly less cost, and at a slightly higher price than your competitors. This step is also important to prevent pricing yourself out of your market – it is a vary rare business that is able to have a similar offering, charge far more than the competition, AND stay in business for long.

Costs

Always have a very accurate understanding of what your costs are, and therefore how to price to protect your profits. Most likely your costs creep and move all the time – even something as simple as your electricity bill increasing. This is the primary reason you will need to hike your prices too. Here are several methods available to help you drill down from the big overall numbers in your P&L to the cost of each item produced – Pricing Products and Services

Assessing your Competitors and Costs will help you set a “basic price” and keep your business ticking along. Regularly ensuring that you are still competitive in your market, and pricing to cover all your costs, are the first two steps in protecting your profits. However, to maximising selling price there are extra steps, more research and calculations are needed before finalising your optimum price and arranging a price hike to get there.

Customers

The next factor for securing a price hike is to work out exactly how much your customers will pay for your product or service. I could go on for hours about the economics of supply and demand curves and how lower price = higher demand, but I don’t necessarily always subscribe to this ‘old school’ approach – especially in relation to high-end services and luxury items. Suffice to say Customers will try to get the lowest priced offering that meets all their wants and needs. The key here is that their WANTS and NEEDS may not be completely obvious so spend some time digging about to really understand what drives them to buy from you.

Content

Instead of using a market driven approach to pricing, switch to using a value approach – make sure the content of your offer is clearly understood; your value proposition is front and foremost. Leverage the perception of value so you can hike prices accordingly. This takes a more holistic approach to customers needs and wants by considering customer feelings – Do they like you? Is the design appealing? Does your offering make them feel good?

A great example of how this method can work is fair trade coffee – it is consistently more expensive in a bag and in a cup. Initially the market for coffee was very clear, there were lots of competitors and customers so the price was very stable and the profit margins pretty consistent. But, by raising market awareness as to the conditions the coffee was grown and picked in and offering a more expensive alternative that drove to prevent the bad conditions the market was opened up to a more costly product. The benefit to a customer of fair trade coffee is exactly the same as that of regular coffee – they are as tasty and satisfying except that the fair trade coffee has an extra value proposition – it also enables the customer to directly support poorly paid communities; there is an added value of ‘feeling good’ that enables a higher price to be charged.

If you are a start-up building a value perception recognise that can take a little while, especially given ‘value’ for services is usually built on trust and testimonials. Having a go-to-market strategy that incorporates a ‘trust building’ and ‘value demonstration’ component will be necessary to implementation of this kind of pricing. So start low, and then hike your prices regularly as your reputation and customer base improve.

In addition to the perceived ‘content’ of your offering there is also a ‘respect’ element. There are boundaries where this stops working but in principle:

  • The more you charge, the more you are respected
  • The more you are respected, the more your clients comply with your recommendations
  • The more they comply, the better the results they get
  • The more results they get, the more clients you get
  • The more clients you get, the more you charge
  • The more you charge, the more you are respected

Customers want and need to be informed of changes that impact them, so a warning the prices are rising is valuable for reducing fallout – “To be able to continue to bring you the fabulous products we know you have come to love, we are going to be charging slightly more from 1 July. We intend to minimise this impact on you as much as possible and look forward to your continued support. Should you have any questions please don’t hesitate to ask….”

The bottom line…

Here’s to reasonably Hiking your Prices (even just a tiny bit)!

PS. It is also important to understand the difference between your mark-up and your margin.

Eve Blackall is a ‘business fixer’. Using her Profitology and Exitology  frameworks, she solves the two biggest financial challenges of any business: making more money, and keeping more money. Previously a Group Financial Controller for several top 100 ASX listed firms, in addition to operating her own highly lucrative practice. 

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