Costs Spiking? The Right Price Moves can Offset the Impact

Like so many of us, Phil is pressed for time. An avid mountaineer, when he prepares for a climb he wants to train just enough that he can summit and descend in a safe amount of time. He has a strategy (certain amounts of running and stair-climbing) to achieve that fitness level.

Last year a back injury precluded his usual training approach. The injury didn’t mean he couldn’t prepare to perform at the required level. However, it did force him to look for alternative strategies to train.

Too Many Cost Pressures

Likewise, firms in diverse industry sectors suddenly find that they need new pricing strategies. They’re facing input cost pressures so big that pulling their usual levers (e.g. competitive pricing, cut other costs, try to get more volume) likely won’t be enough to let them achieve their profit plans for this year and next. A few examples:

• Services firms in many labor markets have had to boost wages and salaries to attract and retain employees or comply with minimum wage hikes
• Many OEMs and contract manufacturers of components face rapidly increasing costs for steel and aluminum
• Fuel prices and a driver shortage are ballooning expenses for shippers

Many execs and owners avoid increasing prices if they possibly can. For them, it is not normally one of the levers they pull to achieve the profit performance required. (Is this you?)

I understand. You worry about competitive pricing and losing the volume needed to utilize your capacity. On the other hand, you also realize that margins squeezed too low means disaster.

This year you may have too much input cost pressure to leave your selling prices where they are. This challenge can place your company’s future financial results at risk, putting pressure on you to find solutions.

Your options for increasing prices:

1. An across-the-board increase
2. Selective increases

In this letter, I’ll encourage you to avoid the first option and offer three tips for the second.

Across-the-Board Price Increases Leave an Across-the-Board Pricing Problem

An across-the-board price increase can buffer higher input costs. The good news stops there.

Contract manufacturers and B2B services firms typically use a cost-plus pricing method, modified to reflect competitive pricing when it’s known. This approach ignores value to the customer. A cost-plus pricing method inherently leaves money on the table with some customers and passes up other transactional opportunities that could contribute profit.

Across-the-board price increases to recover higher costs leave that distortion in place and can make it worse when percentage increases translate into dollars.

How to Increase Prices Selectively and Accomplish Two Objectives at Once

Determining which prices you can raise—and by how much—takes work. Yet doing so allows you to not only offset increased costs, but also rectify existing distortions in your pricing and profits.

The first consideration in pricing strategy decisions should be “What’s the price — or range of prices — at which my prospects and customers are willing to buy?” 

Covering your costs with enough left for a pre-tax profit margin is important as a second pricing consideration. You can think of it as a reality test for the prices you’re discovering in the marketplace. This consideration, along with generating enough volume, will affect the prices at which you are willing to sell. 

Instead of increasing prices across the board, figure out where customers would likely pay more if you didn’t give them the opportunity to pay less, and where you’ll risk little by being assertive.  Here are three tips on how to be selective in how to increase prices:

• Analytically find where you can selectively raise prices for some products, some customers and some transaction types. If your business has repetitive transactions on standard products or services, turn your transactional data into graphical reports that allow your team to see outliers at a glance. The graph below shows that some of the example firm’s lowest prices go to small customers (a fact that surprised the firm’s leadership).

• Develop a deeper understanding of profitability by customer. Different customers often have different cost-to-serve, affected by frequency of purchase, quantities and mix, sales effort required, and level of customer service and support. (The small accounts shown in the graph above turned out to be very expensive to serve.) Customers often pay different net prices and may buy on different terms. Assigning overhead costs to customer segments, and reviewing pricing and terms isn’t easy work. Few organizations have tackled it in depth and kept it current.
  As a result, many companies are operating without a clear, detailed picture of which customers are truly profitable and which aren’t.  Yet companies armed with this actionable information can raise profit levels on lower-performing accounts and strengthen their customer portfolios.  The same is true for product lines and SKUs. 

• Develop a framework for estimating what your solutions can be worth to your target customers—and quantify the estimated financial value of your solutions.

Value to the Customer should be a major consideration, but very likely isn’t systematically incorporated into your pricing methods today.

Price using a strategy that balances value to the customer, prices of the customer’s alternatives, and your own financial requirements. Develop pricing practices that align with your goal of getting paid what your solutions are really worth. Equip your team to execute those improved practices, and align the team with your pricing improvement goals.

Some of this isn’t easy to navigate on your own. Should you need assistance, please let me know. We help companies find pricing improvement possibilities they might otherwise miss and improve how they make decisions about price.

We don’t tell clients what the right prices are. Rather, we provide a process and coaching that helps their teams reach better-informed, practical pricing decisions and implement them. Because more favorable pricing drops right to the bottom line, clients can expect a 6X to 10X return on their investment in our help.

If you see profit potential in enhancing how you price, and especially if your business faces escalating input costs, let’s schedule a quick call. Head over here.