Increasing prices in your annual price increase letter – when, why, how, by how much – is one of the most important and difficult pricing decisions you’ll ever make in a mature market.
Read This CEO Pricing Strategy To Improve Margin & EBIT
At first glance, planning and executing a price increase can seem easy and straightforward. However, it’s not.
Table of contents for this article include:
I. Price Increase Letter: How To Explain Price Increases To Customers?
II. Price Increase: The Strange Pricing History Of Coca Cola
III. Can Rebranding Make Price Increase More Acceptable To Customers?
See whether your pricing is under control
Price Increase Letter: How To Explain Price Increases To Customers?
All businesses go through this phase when you need to explain price increases to customers. It happens when there’s a change in your industry, hence, the resources and services needed to produce your product become more expensive. Definitely, you have to tell your loyal customers that you have to raise prices. It may seem easy but the fact is, it’s not.
Many managers think that all they need to do is:
- Work out a percentage increase in price and apply the increase across the board.
- Fill out a generic price increase letter template with stock standard reasons for the increase.
- Send the price increase letter to customers a month or so before the actual price increase happens.
- Hope and pray the price increase letter doesn’t make your customers nervous and the increase goes under the radar.
Wrong!
Introduction to Price Optimisation 💰 Podcast Ep. 74!
Price increase letters and simplistic percentage increases in prices are very risky price actions. What’s more, they lead to margin loss and angry customers. I highly recommend that you don’t do this.
It takes a lot more than a cost-plus markup and a generic price increase letter to get customers to accept your price rise. The price increase letter is immaterial when the process of setting up the price rise is all wrong.
Today, we’re going to talk about how to plan and execute a price increase properly without losing customers. We will argue that the key to a successful price increase is not the form or structure of the price rise letter itself or how much you increase prices by. Rather, it’s the preparation and process you undertake before and after a price increase. Also, the process you use to make sure your prices and price increase letter are in line with the value or performance you deliver to your customers. To demonstrate this, we’ll go through a real-world case study of a B2B distribution business in Australia. By the end of this article, you’ll have a complete understanding of how to explain prices to customers in mature markets and build some lasting partnerships in the process.
How to Explain a Price Increase to Customers
A price increase letter should support a broader pricing process, not carry the entire explanation on its own. The most effective approach is to:
- Explain the value first. Make sure customers understand the total economic value of the deal and the problems your business helps them solve.
- Avoid broad-brush increases. Instead of applying the same percentage increase across the board, test different price options and consider customer preferences.
- Use customer value to shape the increase. Value discovery can reveal where customers are willing to accept smaller discounts, no discounts, or additional value at an appropriate price.
- Align the letter with your pricing strategy. Your price architecture, discount structure and pricing approach need to support the increase before you communicate it.
- Communicate clearly and genuinely. Customers are more likely to understand a price increase when the conversation connects the new price with the value and performance they receive.
The price increase letter is therefore only one part of the process. The preparation, customer understanding and pricing decisions behind it determine whether customers focus on the increase itself or the value of the overall deal. This is exactly what the B2B distribution business in the following case study discovered.
In an article for Entrepreneur.com, Cardone argues that businesses should not blame higher costs or inflation when explaining price increases. Instead, they should focus on the additional value they provide to customers.
I want you to think of how your business takes a price rise and issues a price increase letter to customers for a moment…
Is it a smooth process or a time of anxiety?
Does it feel like many of your customers just want low prices and tons of value (for free)?
Do you find yourself putting off difficult price increase discussions with your customers rather than passing on costs?
Price increases are not easy.
There are lots of companies with hidden profit potential taking broad-brush price increases in their respective markets hoping that they’ll fly under the radar and stick without too much bother.
A client of mine, for example, from a manufacturer and distributor of essential business supplies, was like this. Their finance team would roll out the same 3% price rise every year knowing that their customers weren’t going to react well.
Each year though, they got more and more nervous about sending out their price increase letter to customers because they were finding every time they raised their prices, their customers would quickly ask for discounts or credit notes (almost as compensation).
After a couple of years of this, however, they were feeling the pressure: Exchange rates were fluctuating, and competition in the market was intense.
They:
- Could no longer fully absorb rising raw material costs and had to pass on some of these costs to the customer
- Had no choice but to increase the prices
- Needed to get a price rise through their wholesale channels to avoid a negative EBIT situation
- Didn’t know how to explain price increases to their customers or how to make sure their price increase letter didn’t create panic and disruption in the market
Key steps in the price increase letter process:
Fortunately, this B2B distribution business understood that its current pricing system was far from perfect. There were a few executives in the business who were motivated to test their assumptions about their customers. There was a small group of people who wanted to develop a better pricing system to announce a price increase to customers and improve their overall pricing capability in general.
So, they formulated a small cross-functional project team and assigned roles, tasks, and responsibilities. Two team members were responsible for arranging some value discovery sessions with their most loyal customers to understand their needs. This included why they bought from the business and the pains and problems the business was helping its customers solve on a day-to-day basis.
To select the right strategy, companies often evaluate various price testing methods before making adjustments to their core offerings. One business manager set about conducting some hypothesis-driven research to test different price options to raise their prices. They were:
Option 1) Increase prices while offering less value.
Option 2) Increase prices without changing how they served the customer or what they offered, only this time offering shallower discounts
Option 3) Increase prices by providing customers with additional value and charging an appropriate amount for it.
(All price trials were performed under experimental conditions and on a low-risk sample).
Smaller discounts or no discounts at all
When they monitored the output from these trials and sessions, they found that a considerable number of their customers, once they understood the total economic value of the deal, were content with much smaller discounts or no discounts at all. They also found that some customers in option two didn’t even notice that the discounts they received were marginally smaller than before – they were just as happy to receive some kind of concession.
These new insights into their customers enabled them to view their customers in a new light. They could see that they had also taken the value they delivered for granted like their customers. They now had a better understanding of how their business fits into their customers’ broader business strategies – and didn’t feel the need to discount as much to win or maintain customers.
It was obvious that price rise discussions were a pretty good opportunity to explain the total economic value of the deal and a good time to segment their customers based on their preferences.
To add…
Unlike any time before, they could see how they could help their customers achieve their financial objectives – whether generating more revenue, reducing costs, reducing risk or driving innovation. As they understood their customer’s aspirations and objectives, they began to take the conversation away from line item prices to strategic problem-solving discussions.
As the project continued, the project team realised they needed a dedicated pricing team to manage and set prices on a full-time basis. They had reached as far as they could go themselves and had done great work. The project started because they wanted to improve how they explained price increases to customers. Now the project was something much bigger. They wouldn’t be able to explain price increases to customers unless they developed a strong internal pricing capability, ensuring their price architecture, strategy, and people were set up properly too.
It was now time to hire specialist pricing talent in the business to run pricing for the business on a full-time basis. They then set up and hired a small team of one strategic pricing manager and two analysts to manage $300M revenue (as the first test case).
Breakthrough: The team later grew in size as they took on more revenue to manage. They now have a pricing function of well over 20 people and growing.
Within the first 100 days, the team reviewed the business’ price architecture. They started with its list price and discount structure. They found that their prices were all over the place! Price ranges were everywhere, with lots of outliers, including RRPs (recommended retail prices) that were either way too high or way too low.
It quickly became apparent that the average selling price was falling each time they issued a price rise letter because there was no price variation across SKUs. Pass-through rates were low and price dispersion by SKU was wide. The top 10% of their portfolio was their high-value and top-selling products. They also had a long list of products outside the top 10%. So they didn’t know which ones were generating profit for the business.
So the new pricing team changed its approach to pricing and introduced SKU price optimisation techniques to set variable price increases across their long tail of SKUs. Part of this involved redesigning their product data hierarchy. This included price elasticity modelling and re-classifying their products into standard commodity items, traffic volume drivers and profit generators. From here, they introduced tactical discounting and set up active rebates with suppliers to ensure agreements were maximising margins.
Overall, the initial price improvement project and pricing team intervention generated an additional 0.5% margin for the business in less than six months. Approximately $1.5M, covering the cost of the program and new pricing team many times over.
See how pricing breaks in practice
Implications
If your customers don’t understand (or have forgotten temporarily) the value you deliver them, then they will not take a price rise well – even if you have a well-crafted price rise letter.
If you haven’t reminded or sold the total economic value of the deal to your customers and then decide to take an X per cent price increase across the board, it’s guaranteed that customers will complain and focus on the price increase and not the value of the deal.
〉〉〉 Get Your FREE Pricing Audit 〉〉〉
Conclusion
In this article, we discussed how to take a price increase in a mature market. We walked through a real-world case study of a B2B distribution business. Also, we looked at the key steps they took to explain their price increases to customers. The key to a successful price increase is not the form or structure of the price rise letter itself or how much you increase prices.
Rather, it’s the preparation and process you take before, during and after a price increase. This refers to the process you use to make sure your prices and increases are in line with the value or performance you deliver to your customers. It’s important that you handle a price increase fast and in a genuine manner to ensure that your customers understand the situation and are willing to stick through it.
We found that a well-structured price rise should provide you with options. This includes the trade-offs of each option and guidance on:
- Where to move
- How much to increase prices
- How to configure a deal to benefit you and your customers.
⇑ Table of Contents
See whether your pricing is under control
Price Increase: The Strange Pricing History Of Coca-Cola
Price Increase: What Can We Learn From The Strange History Of Coca-Cola Pricing Strategy
In modern pricing and investment circles, pricing power is often regarded as the holy grail, meaning the ability to consistently adjust prices whilst growing profitability. Great investors like Warren Buffett regard it as a key component of their investment portfolios – as it demonstrates a strong brand or market presence.
He quoted, ” The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 per cent, then you’ve got a terrible business.”
One of his most famous investments is in Coca-Cola. Although, the strange thing is that for most of its history, Coca-Cola did not implement a single price increase at all.
Why did Coca-Cola not implement a price increase?
The price of a 6.5-ounce bottle of Coke was set at 5 cents from 1886 to 1959. That’s more than 70 years of nominal price rigidity! Isn’t it interesting to note that they were able to maintain that price despite the events that occurred during the 70-year period? The founding of another soft drink industry happened around that time. Let’s not forget, of course, World War I and II, the Great Depression, changing taxes and numerous regulatory interventions. Still, the nickel price of Coca-Cola never changed.
It started in 1899 when two lawyers from Chattanooga, Tennessee went to Asa Candler (Coca-Cola President) to buy Coca-Cola bottling rights. Candler sold the rights to the two lawyers for one dollar. It is surmised that Candler sold the bottling rights cheaply because, during that time, soda fountains were prevalent in the United States. He thought that bottling would never thrive. In the contract, he was granted the ability to “pull their franchise if they ever sold an inferior product”. Unluckily, the agreed-upon price of the contract had no expiration date. Thus, Candler had basically agreed to sell Coca-Cola at the same price forever.
As opposed to Candler’s belief that bottling will not flourish, it did in 1928. It even surpassed fountain sales. Consequently, Coca-Cola had to sell its product for a fixed price because of the non-expiring contract. The only thing they could do was maximise the number of products sold while keeping the price low. In order to achieve that, Coca-Cola began a vigorous marketing campaign to associate its product with the five-cent price tag. They provided incentives for retailers to sell at the same price. The campaign was a great success. In 1921, Coca-Cola was able to renegotiate the bottling contract. The five-cent price remained for over three more decades (the late 1950s).
See how pricing breaks in practice
Technical constraints restricting a price increase
Another factor that prevented Coca-Cola from increasing its price aside from the non-expiring contract was the single-coin vending machine technology. It limited the company’s price adjustment options because vending machines were not capable of dispensing change. Hence, increasing prices was extremely difficult due to the capital expense of updating the machines.
Coca-Cola owned over 85% of the 460,000 vending machines in the United States in 1950. These vending machines were estimated between $286 million and $900 million (in 1992 dollars) based on vending machine prices at the time. The Coca-Cola Company believed that it would reduce their sales and cost money to require multiple coins (e.g., six pennies or one nickel and one penny for a six-cent Coke). Since they were reluctant to double the price, they were forced to keep the price of Coca-Cola at five cents.
The company, however, still explored increasingly innovative ideas to increase its price. In 1953, they even approached the U.S. Treasury Department and requested that they mint a 7.5-cent coin. The Treasury did not grant their request. Coca-Cola attempted again for a price increase. Briefly, they implemented a strategy where one in every nine vending machine bottles was empty. They called the empty bottle an “official blank”. This meant that one in nine customers would have to insert two nickels in order to get a bottle of Coke. This, in effect, raised the price to 5.625. However, Coca-Cola did not implement this strategy on a national scale.
〉〉〉 Get Your FREE Pricing Audit 〉〉〉
Conclusion
This story may appear to be ancient history but it raises some interesting questions regarding the company’s ability to grow market share with a penetration pricing strategy. It is clear that Coke became the most recognised brand in the western world whilst tied to this static pricing model. Despite having a fixed price for so many years, Coca-Cola was still able to make a profit.
Click here to download the whitepaper on The Latest RGM & Pricing Capabilities in FMCG Revenue Management To Drive Total Profitable Growth.
See whether your pricing is under control
Can Rebranding Make Price Increase More Acceptable To Customers?
Price increases are sometimes necessary to offset rising costs. Companies must implement strategies that appeal to customer value drivers at this time or risk experiencing margin loss. There are different ways to say price increase. We’ve found one successful company that has used branding to announcing a price increase and signal price transparency while increasing the price ceiling by a factor of ten using advanced price optimisation techniques. We’re talking about the budget retailer, One Beyond.
In this article, we discuss how One Beyond — previously known as One Below — is using strategic pricing and marketing to effectively communicate value to customers during the risky stage of announcing a price increase. We will also be cross-referencing other real case examples to show examples of what to do and what not to do when you take a price rise.
At Taylor Wells, we argue that customers are likely to accept price increases when coupled with the right marketing and branding strategies. We believe that in the face of inflation, businesses can turn price transparency to their advantage. By the end, you will understand how to strategically raise prices while maintaining customer loyalty.
How Rebranding Can Make Announcing A Price Increase More Acceptable To Customers
When One Below raised its price points last year, it changed its marketing slogan from “everything £1 or less” to “4,000 products £1 or less.” Now that it has raised its prices even higher, with nearly everything costing £1 or more, it has wholly rebranded as One Beyond, with the strapline “Amazing value from only £1.” What prompted the company to announce a price increase?
A Shift In Marketing Strategy When Announcing Price Increase
Chris Edwards and his son of the same name, the same duo behind Poundworld, launched One Below in early 2019.
Following the demise of Poundworld under TPG Capital ownership, the pair hoped to demonstrate that the pound shop model is still profitable, but with a twist.
Selling at prices up to £1, as opposed to only at £1, meant competitors such as Home Bargains would not be able to undercut by a few pence.
One Below is the only brand on the high street that sells everything for £1 or less, with branded and imported items starting at 29p.
But thanks to rising costs, only a small percentage of items remained under £1. Approximately 70% of products now cost £1, with the remainder costing more, up to about £10.
The new approach is a good practice of future-proofing and a way out of the inflationary trap of a £1 ceiling.
For instance, if they kept everything for £1 or less, they would have to remove far too many items from the store. This would be impractical. They can make it work for a while, but it will not sustain their profits for long. The truth is that with all of the inflation, it’s nearly impossible.
So far, about eight stores have opened under the new One Beyond label, while the new pricing strategy has been implemented across 90 stores.
The new model is succeeding, with like-for-like figures up by double digits. They plan to introduce the new brand throughout the country in the first quarter of next year.
So, what’s behind this success? How should you inform customers of a price increase? The key point is how the company communicates value to its customers.
Do Price Match Guarantees Increase or Decrease Selling Prices? 🏷 Podcast Ep. 32!
Discussion on Announcing a Price Increase and Rebranding
Fixed pricing and broad price increases, like many budget retailers with large inventories priced within a slim price bandwidth, are not sustainable solutions; in fact, the opposite is true.
One Below’s rebranding to One Beyond and its announcement of a price increase were not coincidental either. It was well-planned and strategic. In reality, the business’ mix of rebranding, marketing approach change, and pricing strategy embodies the benefits of price transparency.
For example, if they implemented a price rise under their old proposition, customers would instantly reject the increases and lose trust in the brand. On the other hand, they would not have made enough money to cover their costs if they had kept their prices the same. The company had to do something else or risk losing money or, worse, going out of business.
Hence, ‘One Beyond’ basically used their new branding as a platform to communicate the value of their new proposition to customers while escaping the £1 price ceiling that had long capped their profitability.
They strategically optimised 7,000 SKUs until about 70% of their highly visible products cost £1 while increasing the price band for all other products to £10, optimising price points within that band.
There are several circumstances where an increase in price becomes controversial for customers – as shown by the recent Ticketmaster and Netflix price rise strategy. Some say that pricing changes are dismaying, inconvenient, and disagreeable.
One of the most recent price increase outrages was when Ticketmaster used dynamic pricing to sell a significant portion of tickets for Bruce Springsteen’s upcoming tour for more than $4,000 (£3,300). Many people thought this was absurd.
Netflix is another example of what not to do when announcing a price increase. After a decade of rapid expansion, the streaming platform lost 200,000 users in April for the first time since 2011. Netflix expects to lose another 2 million subscribers in the current second quarter. This puts the company on track for its worst year yet. What is the cause of this decline? Hiking prices.
The basic plan for the service is now $9.99 per month, up from $8.99. Its standard tier now costs $15.49 per month, up from $13.99 previously. Finally, Netflix’s 4K tiers have increased in price from $17.99 to $19.99 per month.
Membership growth has slowed in the last year and remains below pre-pandemic levels. Price increases exacerbated the situation.
These kinds of negative outcomes are why many business owners are hesitant to communicate price increases clearly. If not addressed immediately, public outbursts and negative customer feedback may occur, influencing the inability to retain customers.
But what they didn’t realise is that the price increase isn’t the real issue. It’s a loss of balance between pricing and value.
One Beyond ensured that they would be able to provide reasonable justifications for price increases that are in line with customer values. For example, by rebranding and being open about price increases, they demonstrate to customers that they are not willing to sacrifice product quality just to keep prices low.
Customers are well aware of rising costs, and by increasing its prices, One Below gives the impression that it is still offering the same value when raising its prices.
Another key marketing strategy One Beyond applied to raise its brand profile and prices at the same time was by emphasising the quality of its product portfolio. For example, they explained how their price increases benefited their customers. They also pointed out how price increases would enable the business to continue to deliver value to customers.
Customer value related to ‘quality’ revolved around several researched and proven customer value drivers. Things like: product range and breadth; household brands that are known for their effective performance and safety; and continued supply of customers’ favourite brands.
This value-based price rise communication is important because it reminds customers of why they buy from One Beyond. This was not just about bland quality assurances or price match guarantees that create more work for customers. What’s more, value-based communications gave their customers a valid and justified reason for the price increases. Which otherwise may have been perceived as profiteering or price gouging.
So, what lessons can businesses take away from One Below’s initiatives? Can other businesses use value-based price rise communications?
See how pricing breaks in practice
Implications of Announcing A Price Increase And Rebranding
Marketing, branding, and pricing are all powerful business forces that influence customer perception. Thus, businesses must take their time developing strategies for how these three aspects can work together effectively.
Implementing transparent price increases and communicating them, along with the value that your company offers, is a wise move. It instils confidence in your customers that you conduct trustworthy business and get the value they pay for.
Transparency in price increases, when done correctly, enables companies to negotiate with confidence. This way, they can maintain good relationships with customers and suppliers. This is what One Beyond is trying to do.
Retaining competitive pricing on bestsellers while optimising the long tail is an untapped pricing opportunity for businesses with a large product inventory.
A full review of your product price architecture enables retailers like One Beyond to introduce a new higher-priced range of products into the store, attracting a new set of customers willing to pay higher prices.
〉〉〉 Get Your FREE Pricing Audit 〉〉〉
Bottom Line
One Below made good use of value-based branding, pricing and advertising through One Beyond to maximise margins. It’s brilliant to see retailers trying and succeeding with strategic pricing and marketing strategies. The good news is that this success in announcing a price increase can happen to you. No matter what industry your company is in or how big your company is. You simply need to work with the right pricing team.
Our findings show that with the right set-up and pricing team in place, incremental earnings gains can begin to occur in less than 12 weeks. After 6 months, the team can capture at least 1.0-3.25% more margin using better price management processes. After 9-12 months, businesses often generate between 7-11% additional margin each year as they identify more complex and previously unrealised opportunities, efficiencies, and risks.
Read This CEO Pricing Strategy To Improve Margin & EBIT
Are you a business in need of help to align your pricing strategy, people and operations to deliver an immediate impact on profit?
If so, please call (+61) 2 9000 1115.
You can also email us at team@taylorwells.com.au if you have any further questions.
