Have your costs increased? 4 Reasons customers will accept a price increase
At a glance:
As China cleans up it’s manufacturing companies, some raw material prices are increasing or are scarce.
While never easy, passing on cost increases can be done with a simple explanation, communicated clearly to sales and customers.
The amount of increase possible will depend on the competitive context.
Don’t forget to use your other commercial policy levers!
China is working to reduce it’s considerable environmental pollution, closing and upgrading manufacturing sites. In many cases this is causing significant price increases and shortages, creating a conundrum for downstream manufacturers about if and how to capture the lost margin.
As China cleans up it’s manufacturing, price increases and shortages are a consequence.
Here are the 4 reasons why your customers will accept a price increase to cover your cost increase:
1. Customers are willing to accept suppliers passing on higher costs.
Imagine the following situation: right after a snow storm a hardware store decides to increase the price of snow shovels from €15 to €20. Is this price increase fair?
Economists and business people would argue that it is completely fair. After all, the shop has been maintaining inventory and now demand has increased. A higher price will better match supply and demand.
However, in research conducted by Nobel prize winners Daniel Kahneman, Richard Thaler, and Jack L. Knetsch, 82% of respondents considered it either unfair or very unfair of the store to take advantage of the shortage!
Now imagine a second situation in which the same store’s procurement cost to buy the snow shovels increase by €5 from €10 to €15. The store decides to adjust the price accordingly to €20. Is this fair?
In a similar study, 79% of respondents considered the price change as fair. There is no absolute rule about what’s fair in pricing. The key question to consider is what do customers consider as fair? Answer: Most customers consider a cost increase as a fair and reasonable motive for a price adjustment.
This applies in B2B sales as well as B2C.
2. In tough situations pass on only the € cost change (not %).
Maintaining the Gross Margin % is best for margins (increasing the price to €22.50 in the above example maintaining a 33% GM), but risks pushback from customers given the extra €2.50 above the cost increase. At a minimum, capture the actual cost increase (€5 in this example), with a little for added secondary costs such as inventory carrying costs etc., depending on the competitive environment.
3. Consider the competitive situation in setting the increase.
Context matters in price increases. Are your competitors also facing the same cost increases? Can your customers also pass on the price increase to their customers? These factors help you decide how much increase to pass on.
In cases you might choose to forego a short-term price increase for a customer commitment to increase purchases of unaffected products. It all depends on your priorities!
4. Prepare a good story with clear argument; Over communicate!
Many sales people try to avoid a price increase discussions. Convincing them of the need to increases prices and arming them with arguments can make a huge difference!
o Explicitly link the price change to cost changes
o Provide supporting evidence of cost changes
o Present good motives, such as “Price will support environment changes”
o Choose your words: “price adjustment” rather than “price increase”
o Make sure sales understands the customer incentives that can lower prices, e.g. volume rebates, early payment discounts, etc.
o If passing on the full increase seems impossible, try to gain customer commitments around volumes or other behaviors you want to encourage.
This article was co-written by Ofer Levi and myself. There’s lots more to increasing prices of course…get in touch if you’d like to know more.