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Costs Are Up, Now To Sell the Price Increase

March 2011 Pricing

Growth in China is driving ore and mineral prices up, revolutions and unrest in the North Africa and the Middle East are driving oil prices up, and low crop yields in Russia and India are driving grain and onion prices up respectfully.  Executives are living in a time of strong market disruptions that are driving costs up across industries.  The recession already squeezed the potential for productivity gains to make up for the lost margins.  Now, for many executives selling tangible goods, it is time to push the price lever up.

Many executives have accepted the decision to increase prices as a requirement for ensuring a healthy firm that can continue to profitably meet customer needs.  For these executives, the challenge isn’t “Should we raise prices?”  Rather, it “How should we raise prices?”  Should executives do it slowly or quickly?  Are they advised to keep it quiet or make a fuss about it?  How specifically should price increases be communicated?

What is the best way to communicate the price increase to the key audiences:   customers and competitors?

Addressing Customers

Prospect theory, a thirty year old Nobel Prize winning theory about decisions under uncertainty and popularized in books such as Nudge and Predictably Irrational, provides many directives for managing customer expectations.  One of the simpler ones is bundle pain, unbundle gain.

For executives, the need to unbundle gains is well accepted.  We almost do it intuitively through sales and marketing communication when we mention the key selling points, highlight all the features, attributes, benefits, and utility, and position the product with an emotional appeal and linked to a greater goal.

It is the bundling of gain directive from prospect theory that more deserves attention regarding pricing.  The price paid for a product always induces some pain.  In consumer markets, the act of reaching for a wallet to bring out cash brings great discomfort to many customers.  In business markets, paying for one product means giving up the opportunity to spend cash elsewhere, and tradeoffs always involve some level of discomfort.

When prices are going up, they will cause customers more pain.  However, this directive to bundle pain provides clarity into the best means of enabling customers to accept a price increase:  do it all at once.

For instance, consider a company that realizes that they need to drive through a 30% price increase over the next 3 quarters.  They could raise prices by 10% a quarter, they could raise prices by 3% a month for the next 10 months, or they could do it all at once with a whopping 30% price increase.  Prospect theory indicates that a single large price increase would be better received than a trickling of smaller price increases.  Therefore, the company would be advised to announce a 30% price increase to its customers rather than announce a lot of small price increases over time.

Note, announcing a 30% price increase all at once doesn’t’ imply that the price increase has to be taken all at once, just that the customers have to hear, understand, and know about the impending price increase all at once.

The goal is to prepare the customer for the impending price increase.  It may be rolled out overtime, but the knowledge of the impending price increase should come all in one announcement – bundled up as one big realigning price increase.

In an analogy, consider a patient getting treatment for a disease.  They have the choice between getting one big nasty shot and then going about their lives or selecting to receive 10 painful shots over the next 10 weeks.  Most patients select to have the big nasty shot.

In the same way, if customers are told of a small price increase in March, then they are told of a second in April, and a third and fourth and so on until 10 small price increases have been announced and delivered, they are likely to feel as though the company is slowly nickel and diming them to death.  However, if they are told in March that a 30% price increase is coming, and that the firm is rolling it out over the coming months, they are likely to take the news, be unhappy about it, find a way to adjust, and then move on with a positive relationship.

Hence, bundle your price increase into one big one.  Don’t let it dribble out over time.

Addressing Competitors

One of the real challenges to raising prices is doing it alone.  If one company raises prices and no others follow, that firm will soon find itself hemorrhaging customers.  While it might be nice to coordinate price increases across competitors to ensure that a price increase is industry wide, such direct collusion is simply illegal in the EU and US.

Although direct coordination is illegal, indirect signaling of the need to move in a common direction is generally accepted as legal.  (Legal disclaimer:  I am not a lawyer nor am I giving any specific legal advice.  Contact my friends at Pugh, Jones, Johnson & Quandt for help in this area.)

Hence, we come to the second key aspect of driving a price increase, ensure your competitors know it is happening.  Competitors can learn of a price increase indirectly through reading your published price lists, reading an announcement by the CEO in a trade magazine or press release, reviewing announcements made at stockholders meetings, or even talking with your customers.

The broad increase in input cost is affecting entire industries, not just specific companies.  Hence, it is likely to be in the entire industry’s best interest to realize a price increase right now, not just in one company.  Therefore, if a leader (not necessarily the largest firm, but one of the larger firms) in an industry publically increases its prices, it is likely that others will follow.

But watch out, there are competitors out there who seem to consistently make bad pricing decisions.

Big & Public

These two suggestions for driving though a price increase, to make it all at once and to do it in a way that your competitors will know of it, won’t make your customers like it, but it will reduce the ill feelings of customers and the likelihood of a destructive price war.  This isn’t advice for the risk adverse; fortunately, prospect theory also indicates that we are systematically risk seeking when facing an impending loss.  Therefore, executives will be well advised to deliver the big nasty public announcements of price increases in the coming quarter.



About the author

Tim J. Smith, PhD is the Managing Principal of Wiglaf Pricing, and an Adjunct Professor at DePaul University of Marketing and Economics. His most recent book is Pricing Strategy: Setting Price Levels, Managing Price Discounts, & Establishing Price Structures.

Tim J. Smith, PhD
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