Two weeks ago, we wrote about four questions for 2022 based on factors that we can all agree will influence our business this year. We went further and addressed the first question: Is your organization data literate enough?
We’ve received some interesting comments related to the need for greater data literacy in organizations. This would enable better examination of weak links in the supply chain, operations process improvement in areas susceptible to disruption, and generally increase organizational flexibility and dexterity across all functions in response to this new “VUCA” world.
This week, let’s dive into the second question we raised: Should you be considering price increases?
What we already know:
Once again, let’s take what we know about 2022, and then apply it to the question:
- It’s generally accepted that inflation in the United States is currently running around 7%.
- Unprecedented supply chain challenges and labor disturbances brought on by the pandemic have throttled output. At the same time, the pandemic has increased various costs (such as increased expenditure on PPE, safety protocols, etc.) leading to both increased business expenses and decreased productivity.
- Conversely, unprecedented fiscal and monetary stimulus has turned demand in the opposite direction to supply.
- Unemployment rates are at historical lows, creating additional worker shortages and upward pressure on labor costs (meaning additional incremental business expenses).
Great, but so what?
No one knows whether current inflation rates will be a short-term aberration or a long-term reality.
Equally, while supply and demand-side economics may eventually achieve equilibrium, it is highly likely that post-pandemic business expenses will be higher than pre-pandemic ones, affecting profit margins.
In order to maintain profit margins, businesses can do three things:
- Decrease expenses
- Increase prices (to increase like-for-like revenue)
- Increase volume (to decrease relative costs, increase relative margin through economies of scale, and boost revenue)
An oft-quoted McKinsey study succinctly lays out the comparative effectiveness of these three strategies:
“A price rise of 1 percent, if volumes remained stable, would generate an 8 percent increase in operating profits – an impact nearly 50 percent greater than that of a 1 percent fall in variable costs such as materials and direct labor, and more than three times greater than the impact of a 1 percent increase in volume.”
Put simply, like-for-like, price increases are far more effective than the alternate strategies.
In the context of 2022, one could also contend the following: While effectively implementing price increases is difficult, it will be even more difficult (nigh impossible) to cut your way to margin maintenance or to increase volumes significantly enough, bearing in mind the expense pressures we are all facing.
But there’s the rub: effective implementation of price increases.
The stigma of price increases
We’ve been involved in multiple price increase projects, and we can tell you the following:
- Most organizations don’t like asking for price increases (and are bad at implementing them when they do)
- Most customers don’t like price increases either
- More than 50% of the time, the net impact of price increases (after concessions to big customers) is either break-even, or negative
- Done badly, price increases can (negatively) affect customer relationships.
However, can your business afford not to raise prices right now? If you cannot, what should you do?
Data disarms. It’s hard to argue with evidence of increased expenses outside of your control, and customers with professional procurement functions will appreciate a fact-based approach.
In addition to a clear business case, customers respect vendors who communicate clearly. Your message should reinforce shared values, mutual respect, and commitment to an ongoing and mutually beneficial business relationship.
Plan, Plan, Plan
Achieving effective price increases is an important muscle in your business. If you are out of practice, the best way to overcome this is to invest the right amount of time, resources, and executive oversight into planning and managing your price increase activities.
Based on the extreme levels of expense increases your business is experiencing, you may have no choice but to consider increasing prices. This does not mean that expense reductions are impossible or inadvisable (see the third post in this series), or that increased labor costs cannot be mitigated longer term (see the fourth post in this series), but increasing prices effectively is going to take some time and effort, and you may not have all the resources, experience, and expertise to do this on your own. If this is the case, Core Catalysts may be able to help!
Thanks once again for reading. Please share any thoughts or comments you have, and we’ll see you again in two weeks for the next question in the series: Have we adequately reviewed business cost structures and all major business expenses in light of how business has changed?
– Mark Jacobs, Client Service & Delivery