The idea of raising prices can inspire fear and dread for all sorts of business owners. No one wants to hike their rates and see business plummet in response.
But raising prices at regular intervals can have a significant impact on your bottom line. Consulting firm McKinsey found in a study that every 1% increase in prices for S&P 1500 companies resulted in an 8% increase in operating profit (granted volume remained the same). That increase was almost 50% more than the gain a business sees if costs declined 1% and three times greater than if volume increased by 1%.
Knowing when to raise prices isn’t an exact science. There aren’t any one-size-fits-all rules dictating when to raise rates, but there are some telltale signs it might be time to make a move.
If you're thinking about raising prices for your business, ask yourself if the following situations apply to you.
1. Prices Have Been Stagnant for Awhile
The cost of doing business can change over time, thanks to inflation, supply chain costs, and other variables out of your control. All of those cost increases have to be reflected in your prices if you want a viable and sustainable business. For example, take a toymaker that sources most of their supplies in China. New and fluctuating tariffs may raise the cost of that material. If those costs aren’t passed on to your consumer, profits may suffer.
If you’ve been holding prices steady for a year or longer and it’s getting costlier to run your business, it's time to consider charging more. To ascertain how much you should raise prices, look at the costs of doing business compared to your profit margins. If they are shrinking from a year ago, consider adjusting your prices in line with that data.
2. Your Competitors Are Doing It
Undercutting rivals may be a great way to lure customers your way, but it’s usually not a profitable way to grow. Most companies don’t compete solely on price, but on the added value they offer customers. While the lowest-cost provider may gain market share, it will be from the wrong type of customer: those looking for a product or service on the cheap. They tend to be less loyal, ready to jump to a rival who offers them a better deal.
Following competitors to lower prices doesn’t make much sense, but raising prices in lockstep with them does. If your rival raises prices, that can indicate the business thinks its products or services are more valuable than what people are paying today. Staying in line with others in your industry ensures prices don’t erode for all players.
Be mindful of state and federal laws when taking the lead from a rival. It’s OK to follow what your competitors are doing, but you can’t conspire to raise prices together. That can be considered collusion and can get you in trouble with regulators. And make sure you can back up any price increases you institute; you have to be able to demonstrate why customers should pay more for your goods and services, as well.
3. You're Swamped with Business
Working around the clock to fill orders, or staring at a backlog that’s growing could be indicators it’s time to raise the prices for your products and services. If business is booming, you're clearly doing something right.
Raising prices can also weed out a customer segment that is preventing your business from growing. Those who care about price alone will jump ship if you raise prices, while the ones that value your product or service are more likely to stay onboard. That gives your business more time and energy that can be focused on retaining your loyal, higher-volume clients.
Increasing retention among existing, high-volume customers can pay off big time. Bain & Company found improving retention by just 5% resulted in profits increasing anywhere from 25% to 95%.
Red-hot demand is great, but only if you can support it. Increasing the rate you charge means you can hire more staff, purchase extra inventory, and position your business for future growth. Accenture found companies that have the time to embrace strategies to increase agility, responsiveness and innovation are three times more likely to generate above-average revenue growth and profit, compared to those that don’t.
Always Remember: Stick to Your Guns
Some business owners are afraid to raise prices—even if they are justified—as fear of losing business paralyzes them. But keeping your pricing stagnant isn’t a way to achieve sustainable profitability. By raising prices you can boost growth as the quality of your customers improve, expand your profit margins, and free up time to focus on new products or services, all of which are key ingredients to a thriving and long-lasting enterprise.