In Pursuit of Profit
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In an article on how consumers are responding to inflation Andy Pandharikar explains,
For many years, the inflation rate in the United States has been relatively low, hovering around 2%. However, in recent months, that rate has increased dramatically, nearing 7%. However, if we measure according to the Bureau of Labor Statistics’ methodology from 1980 that figure exceeds 13%. Inflation in specific categories like ground beef has been even higher, nearing 20%. As prices rise more quickly than wages, many consumers are finding it difficult to afford basic needs.
Of course, the risk for businesses is significant. Improperly managed pricing can either cost the company its customers or its profits, either of which ends in failure. Prices need to hit a sweet spot where they can generate profitable revenue and are because enough people are buying.
So, during times of high inflation, how should you adjust your pricing to respond? Should you just raise your prices across the board by whatever the current inflation percentage is to cover your reduced buying power? Well, you could. However, that is not typically the shrewdest strategic move. Here are 9 better strategies for combatting inflation:
Increase Prices on Add-On Items
One strategy companies use is to maintain pricing on core revenue-driving products and only increase prices on secondary items like add-on features. Keeping prices the same on essential products or services and only increasing prices elsewhere on supplemental offerings can allow businesses to stay competitive while also counteracting inflationary cost increases. Unfortunately, unless add-ons are significant revenue generators, this strategy may not be enough to move the needle. Instead, it may be better utilized in conjunction with another pricing strategy.
Another option is for businesses to increase costs for surcharges that they already have in place. Fees for things like rush delivery, customization, order quantities that are less than the normal minimum order requirement, making post-order changes, and so on cover a company’s added costs when customers need things outside of the normal scope of business. Maximizing these types of surcharges can help a business counteract the cost of added labor incurred as a result, since labor costs are affected equally alongside materials and production costs when inflation is high. Again though, unless these types of fees represent a large portion of a company’s revenue, changing them may not be enough.
Reallocate Price Differences
A more widespread, but still not all encompassing, option for raising prices is to allocate price increases unequally. For instance, companies that typically offer discounts or promotions can maintain those discounts for more price sensitive audiences, opting to pass on price increases to audiences that can better absorb them.
Typically, this involves tactics like maintaining discounts for longstanding customers but increasing prices for new customers. However, it can also take the form of maintaining discounts on the types of offerings that highly price-sensitive audiences tend to purchase while raising prices on offerings that are being purchased by less price-sensitive groups. In some cases, though, this pricing strategy may involve unbundling products or services to distribute price changes in varying measures to different offerings.
In other instances, bundling, not unbundling, is going to be the smartest strategic pricing move. Companies can take the sting out of price increases by offering more alongside core offerings. Bundling lower-cost items and services with core products can increase their perceived value, thereby justifying their higher price. In this strategy, adding slightly to the cost of a product or service can command a much higher price, making the profitability net change positive. This can be a very powerful approach to take, but it also requires significant internal changes across sales, marketing, and accounting/finance to ensure its success.
An easier version of this same approach is to allow customers to create their own bundled offerings by providing a discount for purchasing multiple products or services together. The discount being offered must be enough that it incentivizes adding additional offerings to increase the average order value (AOV) but not so much that it negates the purpose being doing so.
In times of increasing costs and shifting buying behavior creating tiered versions of your most popular products or services (ex. following a “good”, “better”, “best” model) can give customers options at multiple price points. This enables customers to determine what they want versus what they need and how much they are willing to pay for that tradeoff.
The key to making this successful is paying attention to quality at each level by considering the things that customers will pay more to receive. A Harvard Business Review article on strategic options to deal with inflation further explains this concept in saying,
Quality sensitivity comes down to the features that customers could live without or accept at a lower level. If a product or service has several such features, managers can consider whether removing or adjusting them create[s] opportunities for new versions with fewer features at a lower price point. The converse also holds true. Slight changes in quality can unlock much greater willingness to pay without a significant increase in costs, allowing the company to establish new offerings at the higher end of the market.
Overhaul your Pricing Model
With any increase in a company’s existing pricing its customers are likely to notice (and possibly respond negatively). This is often management’s biggest concern with price changes. However, when a company overhauls its entire pricing model to provide new offerings (as a result of bundling, unbundling, repositioning, etc.) it is no longer an apples-to-apples comparison of “then versus now.” That means companies can present pricing changes for their customers to look at through a different lens. Taking this route may be a good approach for companies that significantly altered their product mix during the pandemic and have not changed their pricing model since to reflect these changes.
Monitor and Analyze Price Changes
Remember, no matter how you choose to change your prices, you must closely monitor purchasing in response to these changes to make ongoing tweaks. It is important to understand not only who is purchasing what and how much they are purchasing but also what they perceive the value to be of what they are purchasing because there is a chance that your business is selling products at below their perceived value. If this is happening, it indicates an opportunity to raise the price there in the future to align with this higher perceived value.
Pricing changes are seldom one-time events, which means that companies should not expect to take a “one-and-done” approach with their pricing strategy. Instead, businesses should analyze their sales data to determine what is working and what is not and make ongoing strategic adjustments to yield better results.
Focus on Costs Instead
Where pricing cannot easily be changed, businesses can focus on reducing expenses (changing vendors, holding less inventory, outsourcing work, reducing packaging, etc.) instead. If there are ways that a company can cut costs without sacrificing product/service quality, it can combat inflation by improving margins from that side of the equation instead.
Finally, in some instances the best way to fight inflation is neither increasing prices nor cutting costs. For companies that have core products driving the majority of their revenue and a solid base of satisfied customers, it may make sense to focus solely on that key area.
So, instead of increasing prices across the board or trying to cut operational costs, reducing SKUs may be a better option. If a business can focus on its core offerings and prune the SKUs that are not strong revenue drivers, it will be reducing expenses in a way that does not affect its main offerings. In fact, it may even allow the company to strengthen its offerings by focusing personnel and company resources on its main offerings to better pull key profit levers. In the end, the business will be stronger and better poised for future growth.
Knowing how to adjust prices in response to changing economic conditions is never easy. Before making any pricing changes, businesses must have accurate cost data to maintain profitable margins. Lean on your senior accountant or controller to provide timely and accurate financial reporting to guide your pricing decisions.
If you do not have the kind of financial personnel in-house to help you make these kinds of decisions with confidence, please reach out to us. We have a team of highly experienced accountants ready to help your company respond to rising inflation with sound financial business decisions. We provide a wide range of consulting accounting services to help businesses get the financial help they need as well as accounting and finance recruiting to help companies hire financial personnel more effectively.