Business Survival Series: Should a struggling business raise prices?
When a business struggles, change is needed to get that business moving in the right direction. One tactic that could be implemented is increasing prices.
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When a business struggles, change is needed to get that business moving in the right direction. One tactic that could be implemented is increasing prices. Some small-to-medium-sized enterprise (SME) directors will be hesitant to consider this option, but oftentimes, price increases are sensible. SME directors may be scared that they will lose customers or clients as a result of price increases, but as Gary Sutton acknowledges:
‘Price increases are often necessary. They force scrutiny, which is healthy. It isn’t always pleasant, but when there’s a problem, nothing flushes out reality quicker.’ (Gary Sutton, ‘The Six-Month Fix’ 2002)
Businesses are free to set their prices and discount their goods and services as they see fit, so why not take advantage of this freedom to help out in a time of financial strife? SMEs that go into insolvency do not price strategically and they are often price takers (i.e. they accept the prevailing market price for their product) who haven’t changed their pricing structures in a long time. Pricing strategy needs to be thought out and implemented with care. This article will explore why you should consider raising your prices, consider how to implement price raises and emphasises why price raises are especially important.
Why are price raises necessary?
Fixed pricing structures can put an incredible amount of strain on SMEs. This reality can be seen in the construction industry. In this industry, contract prices are often fixed but overheads continue to go up as the economy shifts and extraneous events occur. This, in addition to the common occurrence of sub-contractors under-pricing their services in order to beat the competition in this competitive industry, contributes to the construction industry having one of the highest rates of company liquidation in Australia (about a quarter of all company liquidations).
The issues associated with fixed pricing structures are exacerbated when an SME is in a period of financial strife. In such a situation, something needs to change. At the most basic level, businesses function through costs and pricing. Costs are the expenses incurred by making a product or service that is being sold and the price is the amount a customer is willing to pay for that product or service. There will usually be far more leverage on the pricing side of the equation than the costs side. This means that, for most struggling SMEs, it will be easier to raise prices by 5% than it will be to reduce their costs by an equal amount. Furthermore, SME directors tend to underestimate how much room they have to change their pricing structure. Christian Brim (CEO of Core Group) writing in Forbes in 2021 said:
‘My experience is that most business owners have more room for price increases than they realize, but they are afraid to use that leverage.’
Implementing price raises in your business
The general process:
Before implementing any price raises, it is vital that you take the time to collect and analyse the information available to you. It will be helpful to start by determining what your direct costs are so that you can determine your gross profit and gross margin. With this information in hand, we suggest that you list your clients in order of profitability from top to bottom. This is a vital exercise because without a thorough understanding of your client base, you will not be able to implement appropriate strategies. Looking at this list, it will probably be clear that the Pareto Principle is applicable to your business. The Pareto Principle describes the unequal relationship between inputs and outputs. In most businesses, this means that 80% of your revenue is coming from 20% of your customers or product lines. Although the balance may not always be exactly 80% to 20%, for the most part it is a generalisation that is appropriate for describing most businesses.
With this information in hand, you can begin to implement changes. Generally, the most effective pricing structures will be tailored. Instead of introducing blanket price raises, use tactical increases that are informed by the above information as well as each client’s historical relationship and their value to your business. For example, you may offer options for pricing, depending on a range of pre-determined criteria. Alternatively, your strategy may be to price lower than your competitors. If this is the case, be careful not to fall into the trap of under-pricing your products or services to the point where delivery is no longer viable. Alternatively, an indirect price raise may be the answer. Companies can pass on costs through surcharges for fuel, fast shipping, long payment terms, small orders, etc. If your customers are making your services uneconomical through such behaviours, tighten up your processes. Set clear policies and communicate these policies to your customers. This will help you secure your profits without actually increasing product prices. Whatever your strategy may be, don’t be afraid of losing low value customers during this process. Look to cut unprofitable customers if they won’t change because at the end of the day, it is the top 20% of your customer base that is providing the bulk of the value.
Understandably, customers often resist price increases, but you can soften the blow by offering other benefits. You might consider offering volume guarantees or bundles. Usually, your ability to introduce price increases is already built into your contracts. It is common practice to put price contingencies in contracts. Check your own contracts and enforce what is in those contracts.
Raising prices can be a scary process for many SME directors. Try to think of it as a normal business process and get on with it. Develop well thought out strategies, communicate with your customers and implement your changes confidently. Don’t let the fear stop you from making the changes that are required to sustain your business’ profits into the future.
For struggling businesses:
The general process will be helpful for most SMEs, but if your business is already struggling financially, you may need a more rapid response. In a pinch, a potential strategy may be to introduce a blanket 10% increase on every product or service that is not profitable. The outcome will be varied. Some customers will be unfazed by the increases, and the increase will in turn mean that the product or service is profitable moving forward. Other customers may leave. This outcome is not always the worst. Again, the Pareto Principle dictates that 80% of your profits will likely come from 20% of your customers. It is likely that you will make up your losses from those who left with the customers that stayed and accepted the increase. In this way, you have separated the valuable clients who provide real, sustainable value to your business from those that don’t.
Some products or services will not survive a blanket increase, Gary Sutton suggests that these items be reintroduced with a 25% cut. After introducing the cut, you will need to carefully monitor this item. You may find that the volume makes this item a winner. If it doesn’t, you will need to act fast to terminate this item since it doesn’t create any value for your business.
Struggling businesses require drastic pricing changes. These are especially hard to swallow for customers. When implementing such drastic changes, you will need to divert your attention to making these changes more palatable for your customers. Whilst the struggling state of your business will limit your ability to provide alternative benefits, it is still worth considering what can be done within your current capacity. At the very least, be open and communicate with your customers and help them understand why the changes have been implemented. This will assist in creating goodwill amongst your customers.
Why now is a better time than ever to act quickly
The truth is that now is a better time than ever to raise your prices. Markets across the globe are currently facing higher costs for materials, labour, energy and more. Supply chains are bottlenecked and demand is returning to pre-pandemic levels as the world gets back to normal. This is coupled with high inflation, which internationally, is higher than it has been since the 1980s. A similar trend is being experienced in Australia, with the Reserve Bank predicting that inflation will hit 7% by the end of 2022. Whilst we are yet to see how prolonged this level of inflation will be, it nonetheless poses a serious threat to the profitability of SMEs. This will be a novel challenge for most SME directors, who likely have not dealt with such high levels of inflation during their professional careers. So how have other directors responded so far?
Some businesses have already acted but others are paralysed. The fear of changing your business’ pricing structure can be overwhelming. But the current economic climate favours those that act quickly. Furthermore, the current pressing economic situation is exacerbated if your business is already in financial distress. The reality is that there is severe pressure being placed on businesses all across the world, so you should consider doing something about it now. If you haven’t yet experienced the impacts yet, it’s likely that you will. Get on the front foot or get left behind.
Raising your business’ prices is a daunting process. But it is nonetheless necessary to rip the band aid if constraints are affecting profitability. Especially in the current economic climate of inflation, it is necessary for all businesses to reassess their pricing framework to ensure it is fit for purpose and providing adequate profits. It is even more imperative for struggling businesses to think strategically about their prices. In a time of significant financial strain, you will have to make bold moves to keep your business alive. We suggest you collect the necessary information to create a tailored, strategic plan on how to proceed with your price raises and then act. Change is necessary and healthy for any SME.