by Sally Colby
Ann Miller, Extension educator with Penn State Extension’s Energy, Business and Community Vitality Unit, said input costs have gone up for everyone and consumers are behaving differently.
“If there was a weakness in your business, there’s a good chance it was brought to the forefront,” said Miller. “Even in ordinary times, no one wants to increase prices, but very few businesses encounter circumstances where the money necessary to produce what you sell – input goods, costs, materials, marketing, labor – go down consistently. Freezing prices devalues your own labor and limits how you grow and keep what you have. Without a pricing strategy, what you’ve built with your hard work will eventually fail or be challenged.”
Determining costs is the first step in raising prices. Without knowing costs, business owners don’t have the necessary data to make appropriate pricing decisions. While most business owners have a good concept of their costs, more detailed tracking helps establish a better pricing strategy. Simply looking at production costs and the cost of doing business is too narrow a view. “Your costs are more than just raw materials,” said Miller. “Your costs capture your labor and overhead. Too many people discount those costs to their own detriment.”
Most costs fall into two categories: Fixed costs, such as rent, are paid whether or not products are sold. Variable costs, such as shipping, increase in direct proportion to production.
Costs such as marketing, labor and packaging are often overlooked because the focus is more toward pricing, and business owners believe they can recoup such costs later. “Account for everything,” said Miller, “especially your own labor. Your time has value, and if you aren’t paying yourself, you aren’t capturing the actual cost of the product. If you eat your own labor costs, you eliminate the possibility for planning, growth capacity or more customers.”
To develop long-term costing strategies, Miller suggested asking “What is everyone else charging for the same thing, and what can I afford?” Although it’s easy to get caught up in what other businesses are doing, each business is unique. Structure or startup costs, labor or other variables add up to differences in the cost of doing business.
Another factor is that customers can be quite different from locale to locale, and the business owner might be in a different spot in the business cycle. “A new startup has different goals, resources and energy than those who have been around for a while,” said Miller. “Know your competitors and keep an eye on the competition. If you know your own costs, you can develop a pricing strategy that will allow you to compete. If you do not, your competitors set the tone, not you.”
The science behind pricing involves a combination of price elasticity and customer value. “Price elasticity measures the responsiveness of the quantity demanded to the good and its change in price,” said Miller. “It measures how much a particular item people buy is in relationship to its price. Science asks ‘How tied are customers to a price point, and when do we hit that spot when we raise the price and customers either slow down or stop buying?’ There’s an intersection of supply, demand and price that causes fewer goods to be sold.”
Customer value involves what customers care most about in relation to a particular product or industry. What can business owners communicate about their product to increase price elasticity – how can they position goods to get the most amount of money?
“For long term success, knowing what your customers value and how you communicate your own values cannot be overlooked,” said Miller. “People pay extra for goods and values. The question is ‘How do you build value into your goods and services so customers will pay what you’re really worth?’”
Miller suggested reviewing pricing strategies to understand the science related to pricing. For cost-plus, figure in the cost and add a markup for profit. This method is consistent and straightforward but doesn’t take elasticity or value into consideration. With demand pricing, prices move with amount or quality. Some products are very inelastic, so tracking and paying attention to demand is crucial, including awareness of optimum sales windows and making use of them.
Value or economy pricing can be accomplished with high volume and low prices. “This forces you to constantly focus on input costs,” said Miller, adding that consumers can be fickle but understanding them and current trends is key. “If you have items or classes that sell out quickly, raise your prices on those.”
Another strategy is determining what the market will bear. Charging a high price for goods and services, the opposite of value pricing, works great if you don’t have competition but requires knowing customers and trends.
Bundling, such as is done with CSAs, is a great way to increase overall sales. If a local farmer grows kale but also has strawberries, the CSA is attractive as a bundle because the customer gets something they want and maybe something they need, and they’re paying for more than just strawberries. Make sure one “winner” product is included in the bundle. Bundles also help control variable costs such as shipping, packaging or marketing.
If this is the first time your business is raising prices, experiment with just a few items and track the demand change. “Relatively few customers are going to notice,” said Miller. “It’s a great way to see how pricing is affected by demand. Keep an eye on products that move quickly – you may have more flexibility in raising prices there.”
The best way to handle pricing is to implement standard price increases over time. “It’s easy to become comfortable with pricing,” said Miller. “Become accustomed to changing prices and do it with some regularity. That way you don’t have to make a future 50% jump to cover costs.” She noted that the first price increase eventually costs companies more than customers leaving. “You know prices increase,” she said, “so plan accordingly and your customers will adjust too.”
Increasing sales volume benefits the bottom line. Once prices are established, reward customers for loyalty, increase traffic on certain days (such as implementing a senior discount) and use early bird discounts for new products – especially if you’re testing pricing. Reward referrals provided by existing customers and retarget with a custom offer. If the business model allows, offer subscriptions.
Miller said the hope is that a business doesn’t lose customers following price increases, but the reality is they may. “If a business is beholden to a small, vocal group of price-conscious customers, the business may cut costs too much or sacrifice quality and drive themselves out of business,” she said. “By focusing on core competencies and understanding customers’ beliefs and values and pricing accordingly, businesses can increase profits and not lose money or underestimate their value.”