A marketer's guide to increasing prices

Editor's note: Gerald Linda is president of Gerald Linda & Associates, a Glenview, Ill., research company.

McKinsey & Company 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 percent price rise, if volumes remained stable, would generate an 8 percent increase in operating profit. This impact is 50 percent greater than a 1 percent drop in variable costs such as materials and direct labor. It is also more than 300 percent greater than the impact of a 1 percent increase in volume. (The sword also cuts the other way - a 1 percent decrease in price brings down operating profits by 8 percent.)

You might be asking yourself, why would anyone want to discuss how to increase prices now, when the U.S. is still absorbing the effects of a global economic meltdown? The answer, of course, is that this recession will end, just like all other recessions have ended. In fact, according to the National Bureau of Economic Research, it's already over as of second-quarter 2010. (Although the employment rebound has been slow to catch up.) If history is a judge, eventually salaries will rise again, job growth will occur and we'll see both demand-pull and cost-push inflationary pressures. This means price increases.

So gird your loins and be prepared to cleverly negotiate price increases on your goods and services. This task should not be taken lightly. The goal of raising prices, of course, is to generate incremental revenue from those customers accepting the price increase, at levels which exceed losses from customer attrition, decreased sales to remaining customers and/or reduced sales via new-customer acquisition. However, the net result could be reduced revenues, fewer customers and perhaps loss of goodwill even among those customers who remain. Dreadful - on all three counts.

Rarely the only thing

Fortunately, most customers tend to be a little "sticky." There are business and emotional hassles associated with changing suppliers (e.g., accommodating to 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, as Quirk's readers know, research indicates that while price always matters, it is rarely the only thing that matters. So if the price increase is correctly executed, revenues and profits may very well increase.

Most pricing consultants 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 or with certain segments before adopting it everywhere. Some propose marketing research, such as conjoint analysis, econometric modeling or proprietary tools researchers are happy to provide.

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

Pricing strategies

Deloitte Consulting recommends doing what it has termed a SKU 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.

Deloitte also recommends 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.

The Strategic Pricing Group's John Hogan and Tom Lucke, 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; co-op 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 base 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. For example, a recent taxi ride in Chicago cost a dollar more on Thursday than on Wednesday. Why? The price of gasoline had crossed $3 per gallon, which by law permitted a $1-per-trip surcharge. (It also raised the total just enough that I felt compelled to increase the tip by a dollar as well.)

Pricing tactics

Here are a few additional ways to raise prices (selected and adapted from Marlene Jensen's 2005 book 46 Ways to Raise Prices ... without losing sales [www.raiseyourprices.com]).

Psychological pricing can help lessen the blow. A well-known retailing tactic, psychologial pricing suggests that it is often easy to move prices up to - but not beyond - the next psychological barrier. Thus, if the price is $9 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 per 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 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.

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. Newspaper and magazine pages are smaller, and 2x4s aren't 4" wide. Similarly, magazine subscription lengths have been reduced; auto lease mileage allowances have declined, and this is just to name a few.

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.)

Communicating 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 38 percent 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 requiring price changes are always a palatable explanation. And it won't hurt 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, in the case of B2B selling 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.
  • E-mail 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 touchpoint with customers.

There is one proviso: The price increase must not place you so out of relative position vs. the competition that customers are encouraged to also look elsewhere. This requires a competitor price check. Look at their Web sites. Check with your sales force. Ask long-time, trusted customers what the going rates are.

Relatedly, make your 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.

More of an art

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. As with much in marketing, pricing remains more of an art than a science.