In my opinion, business owners worry too much about the impact of price changes on their customers. I have a client who has not raised prices in 4 years. Every year we have the same discussion and I get the same answer; “My customers will revolt if I increase my prices.”
Most clients I work with are continually dealing with rising costs. One of the most significant has been payroll expenses. Those clients I have that employ minimum wage workers have seen double-digit increases in their payroll costs. Even those that don’t have minimum wage workers see an increase between 1%-5% each year.
Many business owners are also dealing with increases in commodity costs – whether it be food, fuel, or something else.
If a business owner doesn’t have a plan around their pricing, they are going to see their margins begin to decrease. Eroding margins due to not increasing pricing means that an owner is willing to take a personal pay cut to pay for the increase in costs rather than pass it along to their customers.
Below I am going to detail three best practices for business owners to increase their prices. When a business owner has a plan and a process they adhere to around pricing, the process becomes mechanical. The great thing about a mechanical process is it takes the emotion out of the decision, and a business owner can place reliance on tools they have put in place.
Best Practice #1 – Raise Prices Annually
There should be a process around increasing prices. I like to tell my clients to raise prices annually, right before the busiest time of the year.
By having a designated time each year when a business owner increases prices, they take the anxiety out of the process. Internally, an owner knows they will raise prices every June, for example.
Raising prices usually isn’t a back of the napkin process. There is a lot of research that goes into it. As such, if an owner knows they will increase prices once a year, they can set up their planning and research to coincide.
Businesses usually see increases in their costs throughout the year. However, some of their most significant increases in costs, such as payroll, can be controlled by them. A business owner could, align the timing of their price increase with the increase in wages.
Some more commodity-based businesses may need to evaluate prices more often. However, this should be kept at a minimum. There are large disruptions to a business when pricing changes. As such, you don’t want to change your price when your costs change continually.
I have a client that operates a few coffee shop locations. Their costs for beans and milk are constantly changing. We evaluate pricing every quarter, however, we set a minimum change in costs that must be triggered for us to contemplate a price change. We then have an annual process where we update all pricing to reflect changes in costs that we might not have adjusted for during the year.
Another advantage of raising prices annually is that a business owner won’t get stuck doing a massive, one-time price increase in any given year. It is much easier to increase prices by 3% every year than it is to increase prices 9% every three years. Customers notice a large increase; most won’t notice incremental increases.
Best Practice #2 – Setup Your Income Statement to Act as a Guide
A quick review of your financial statements can quickly tell if you may have issues with your pricing. Start by looking at expenses as a percentage of total revenue for a period compared to the same period last year. From this review, you’ll quickly be able to see expenses that increased as a percentage of revenue.
The two specific categories this practice is vital is for employee costs and costs of good sold.
Many business owners don’t have their costs of goods sold set up to report correctly. For instance, they will have costs that are truly fixed mixed with their variable costs. A variable cost is one that is depended on the level of output (i.e., revenue). By categorizing these costs together, an owner may not be able to see accurate cost fluctuations.
Several businesses have employee costs that should be viewed as variable, even if they don’t realize it. Take, for instance, a marketing firm that bills out employees to clients. This marketing firm may have four employees who are all salaried. However, their salaries as a percentage of revenue should remain consistent. If these costs as a percentage of revenue significantly increase, then it is an indicator that either salaries increased, but prices didn’t, or there isn’t enough work to keep all four busy.
A well-trained bookkeeper or outsourced CFO can help a business owner better setup their income statement. When setup correctly, an income statement can act as a great tool in this process.
Best Practice #3 – Look around…what are your competitors doing?
I have many clients that I build pricing models so that we can better determine how to price their products/services. Don’t get me wrong, this is important. Pricing without considering costs is never smart.
Most of us have competitors in the market. Few of us have a perfect competitor, meaning someone that offers the exact same services. Never the less, comparing your pricing with competitors in the market can provide guidance.
As a side gig, I run an indoor kids play business that has a small coffee shop. I have put together a small pricing model that helps price our coffee. However, we also use Starbucks pricing to guide us. I often find that my model prices our coffee 30-40% below Starbucks. My target is to be 20% below. As such, I have margin that I would otherwise leave on the table that I account for in this process.
Moral of the Article – Keep Up to Date with Your Pricing
One of the worst things a business can do is not update their pricing regularly. The lack of pricing updates eventually erodes margins to the point where the business may not be viable. Even if it doesn’t get to the point where it effects if a business is viable, it does erode the business’s value.
The most significant step a business owner can take is to establish a process for pricing increases. That process should include a set time when pricing increases are contemplated. It should also include tools, such as a pricing methodology, a model, and financial statements that can aid the owner in establishing their prices. Lastly, the process should include some competitor analysis so that an owner can gauge their prices in comparison to the rest of the market.
If this seems like a lot, it can be. For some businesses that provide one service, the process is less cumbersome. However, once you have multiple services or products, there are often several variables to take into consideration.
Lastly, involve your bookkeeper or outsourced CFO. These resources are comfortable working with numbers and should have experience with this process.
By taking these steps, a business owner is ensuring their business’s value won’t erode over time.
About Krieger Analytics
My name is Matt Krieger, and I am the founder of Krieger Analytics, an accounting and advisory partner for small businesses and franchisors. Our goal is to completely outsource your accounting department from bookkeeping and taxes to CFO advisory services. I am also the owner and franchisor of a concept called Monkey Bizness, in Denver, Colorado.
As a small business owner with a background in finance and strategy, I realized the benefits that a CFO could bring to smaller organizations. Most franchisors and small business owners don’t have a need (or budget) for a full-time CFO or bookkeeper. To better fit my clients, Krieger Analytics is a part-time resource. While most think of CFO’s being involved in finance and accounting (we are), we are also involved in much more. We partner with clients by coaching, giving them clarity into their business, and creating growth strategies. Conversations are free, so don’t hesitate to reach out to me at firstname.lastname@example.org.