Raising Prices When Costs are Rising
Costs are rising on everything! Your raw material costs are rising. Your labor costs are rising. Your recruiting costs are rising. Your energy costs are rising Your freight costs are rising. You are incurring higher costs to overcome supply chain bottlenecks in areas such as overtime, expediting fees, and substituting more expensive materials.
But Are Margins Rising?
These crushing cost increases create significant pressure on your margins. Efficiency improvements and cost reduction efforts aren’t enough to offset these higher costs. The most effective relief valve for this margin pressure is price increases.
If you haven’t increased prices lately, increase them. If you have increased prices lately, increase them again. If you are planning a price increase, do it sooner and go bigger than your current plan. In decades of consulting in pricing, we might know of five companies out of thousands who increased prices too much or too fast. The significantly more common sin is too low and too slow.
OK. A Price Increase. Now What?
Once you’ve decided to raise prices to customers, a flood of decisions must be made about how much (more), how fast (sooner), to whom (everyone, but not by the same amount), on which products and services (all of them, but not by the same amount), and how to communicate it. Check out this blog post to make sure you aren’t over-communicating your price increase. But then, what should be communicated?
It is very common to cite higher costs as the reason to increase prices. It’s sensible. It seems reasonable and fair to customers. And yet we strongly encourage our clients not to cite higher costs as the only reason for your price increase. Don’t tie your price increase messaging too closely to cost. It’s critical to wrap a value message around any cost justification.
Blame It on Rising Cost?
Citing cost as the only justification for price increase makes you vulnerable in two important ways:
First, customers will knock on the door immediately for price concessions when costs drop. When raw material prices return to more reasonable levels, when freight costs level out, when commodity prices normalize, the customers will push hard for discounts. The degree to which you have justified your price increase with cost inflation and value-add makes it easier to hold onto at least a portion of your price increase.
This risk is small if the bulk of your cost increase is labor-driven. We’re very unlikely to see wage deflation in the US market. It’s not going to become less expensive to recruit and retain talent, no matter whether we’re talking about expensive knowledge workers, the trades, or unskilled labor. Once wage inflation happens, it sticks.
However, if your higher cost inputs are commodities, freight, energy, etc., customers will expect a price adjustment in their favor as prices drop. Wrapping cost inflation in value-based messaging insulates you from deflationary downside, at least to some degree.
(Of course, smart companies play the arbitrage game: When costs are rising, pass along the price increases as quickly as you can while you try to delay accepting the cost increases from your suppliers as long as possible. Later when costs decline, secure discounts from suppliers quickly while holding onto price with your customers as long as possible.)
Another Reason Not to Cite Cost
There is a second reason to add value-based messaging to your cost-only justification. If higher input costs are the only justification for price increase, you admit to no increasing value beyond those inputs.
Whether you provide a good or service, you provide value beyond that of your inputs through your manufacturing process, your distribution process, or the service that you provide (engineering, marketing, design, consulting, training, legal, accounting, etc.) It’s not just the steel. It’s not just the labor. It’s not just the insurance. It’s not just the electricity. You take all the inputs and add your magic, and out the other side comes something of value. If you increase price only because of higher input costs, it strips your company of its value. It admits that the only reason you have permission to increase price is because of the cost of your inputs and not because of the value you provide.
While it’s reasonable and maybe even necessary to cite cost increases to justify price increases, never let that be the only justification. Cite improvements to customer value. Michelangelo’s price for the Sistine Chapel wasn’t dependent on the cost of paint.
Easy to Say, But How is it Done?
Here’s a sample price increase letter which cites cost increases but also mentions other value-based improvements faster lead times, tighter tolerances, insulation from supply chain interruptions):