Economy’s down, but can prices go up?

Almost three quarters of business owners plan to raise their prices in the next three months, but increasing prices in a downturn is never easy. We examine strategies you can use to raise prices and examine other pricing strategies to keep sales growing.

It’s a buyer’s market out there. As customers are hit by the slowing economy, rising unemployment and falling wealth levels, businesses across the board are desperately searching for ways to keep sales coming in the door.

Cutting prices is one quick way to spark sales growth. Yet for many companies, this is not an option.

According to Dun & Bradstreet’s latest National Business Expectations Survey, 74% of Australian businesses plan to raise prices in this quarter. This is mainly as a result of the 30% fall in the Australian dollar over the last six months, which has pushed up the price of imported goods sharply.

But raising prices in a downturn is no easy task.

“Businesses need to be careful how this is managed,” says Stephen Byrne, strategy director for brand consultancy Diffusion.

Byrne emphasises the importance of having a communication strategy to manage price jumps, regardless of their position in the market.

“Many customers now use online pricing engines like Webjet and Lasoo to track the best prices and are unlikely to even read or see a rationale for a price increase,” he says.

There might be good reasons for raising prices, but in a buyer’s market it’s likely customers won’t wear the price hikes without very good reason.

“Brands need to provide credible explanations for their decisions,” Byrne says.

Management consultant Peter Gruben agrees. “As a customer I would like see what I get in addition for the price increase, and it better be worth it.”

Defenceable price rise

Phil Bonanno, the director of retail strategy at research consultancy The Leading Edge, says those companies planning to raise price must have what he calls a “defenceable story”.

This might involve explaining to customers that the cost of a key raw material or ingredient has increased, so retail prices must go up. Bonanno gives the example of Woolworths, which uses advertisements filmed in fresh food markets to update customers about price changes in fruit and vegetables.

“Customers get that, they understand that the price of bananas have increased because of the floods. If it’s a defensible story that is easily told, then you’ve got a good case.”

However, if you’re simply raising prices to increase profits, be prepared for a backlash – particularly during this downturn.

“If anybody thinks this is a profit grab, you’ll get absolutely slammed,” Bonnano says.

Help your customers beat the rise

Urging customers to “beat the price rise” can be one way of keeping that trust with the customer during price increases. Companies from Bluescope Steel and Sony to BMW and Doors Galore are taking this transparent approach and allowing customers a little time to purchase before a price jump.

Not only does this strategy soften the blow for the customer, but it also helps drag sales forward and keeps the cash flowing.

Ray’s Bicycle Centre, a Melbourne-based cycling retailer, knew that a weaker Australian dollar was going to hit the business hard – before October last year, a rise of 20% in wholesale bike imports prices was on the way. Suppliers and importers told Ray’s assistant manager Nathan Larkin that things were going to change and the retail business needed to turn its pricing strategy on its head.

Larkin reacted immediately and “bought up big, as much as we physically could”. Ray’s Bicycle Centre informed customers that price hikes were on the way, and urged them to buy early and beat the increases. Larkin says that the up-front pricing strategy has worked well.

“It has been great for us to plan, purchase and advertise. It has given us a stronger market share,” he says.

Ray’s has also reworked its sales margins to reflect this tough market. “If we cut our margins slightly, we still get sales,” says Larkin. The retailer’s prices have been up for two months now and business is steady.

Customers are buying cheaper bicycles, but at least they are still buying. And Larkin is keeping the communication lines open with his suppliers to make sure there will be no nasty surprises.

Get scientific

Just as customers are getting smarter about pricing by using tools such as online shopping sites, companies also need to get smarter and more scientific about they way they implement price rises.

Bonnano says companies should carefully analyse their product range and decide which products are most sensitive to price increases – these are known as key value items – and which products have a bit more price elasticity.

“What are those items in a shopping basket that customers know the price of straight away and they know when it changes?” Bonanno asks. Perhaps you would leave these prices on hold, and look to increase the prices of other goods that are seen more as luxury or premium items.

Companies should even look at their pricing from a geographic standpoint. If a retailer faces stiff competition in a particular suburb or city, then perhaps prices should not rise in this area. If there is little competition in a suburb or city, customers may be more willing to pay up.

This strategy was recently used by fast food giant McDonald’s, which increased prices in areas where customer demand was highest and customers would be more willing to accept higher prices. The company used a new “demand-based pricing” scheme to apply the price increases, although this created some controversy when it was revealed the price hikes would be concentrated in low-income areas.

“When a big retailer makes a price increase, it’s certainly not across all stores and it’s certainly not across all categories,” Bonanno says. “I think from a dispassionate perspective, as consumers and shoppers get smarter about pricing, I think retailers have to as well.”

Product innovation

Another avenue worth considering is product innovation. If you need to raise prices on your premium product (or at least hold them steady) think about whether you could create a budget or medium-tier version to keep customers happy.

Coffee retailer Starbucks is one company that has gone down this path with the introduction of Starbucks Ready Brew, an instant coffee product that has just been released.

While Starbucks would never brand its Ready Brew product as “recession” coffee, the coffee (three sachets for $US2.95) is completely designed to retain customers in tough times. At $US1 a cup, Starbucks has a much better chance of keeping many of the customers who can’t justify fancy $US4 coffees each morning but that want their Starbucks experience. (The added benefit is that it allows Starbucks to diversify into the instant coffee market, worth an estimated $US17 billion a year).

Will raising prices lose you customers?

While three quarters of Australia’s entrepreneurs say they are planning to raise prices in the coming months, many will have to ask themselves if raising prices will cost customers?

Marshall Place Associates entrepreneurship and strategic thinking consultant Colin Benjamin is continually being asked about effective strategies for raising prices in 2009.

This is not a conversation he is prepared to have.

In the current trading conditions, Benjamin is adamant that any short-term benefits of a price hike will be devastated by the likely loss of customers unable to cope with increases. If businesses want to boost sales, they need to cut prices and learn to cope with often-dramatic drops in margins by cutting costs. For those businesses that can’t go past this idea, Benjamin (who is also a SmartCompany blogger) has a blunt message: “They need a new brain.”

He says entrepreneurs must realise the economic benefits of retaining existing customers as well as appreciating the link between quality client retention and profitability.

“Businesses need to calculate the cost of creating new customers, rather than the cost of goods.”

Public relations firm Harvey Publicity is one company that has already frozen its prices. Company founder Clemence Harvey thinks it would be “foolish” at a time when she knows her clients are “trigger happy and looking for reasons to cut costs. So why put yourself in the firing line?”

Harvey’s approach is to cut her budgets, look for new ways to save, mine potential new revenue streams, and add services to keep clients engaged.

Other pricing strategies

This process of bundling products and services, which is also dubbed value marketing, is a popular downturn strategy. Examples include meal deals at fast-food chains, selling three products for the price of two or the classic “buy-one-get-one-free” offer.

Department store Myer regularly uses a “buy one, get the second for 50% off” discount offer, while airlines have resorted to offering deals where a customer buys a seat and a friend flies free. Supermarkets including Woolworths and Coles continue to spruik fuel discounts with purchases. Despite the small 4c per litre savings on fuel, this promotion offers perceived value for supermarket shoppers and queues at every accredited petrol station are testimony to its appeal.

And it is not just retailers; other types of businesses are looking at ways to inject more value into their products and services. Entrepreneur David King launched his digital communications consultancy The Royals 11 months ago. He believes no business can afford to increase prices in this market without offering something extra.

“You have to concentrate more and more on value pricing,” he says. For King, this means strategies including bundling services to keep clients happy and loyal.

A potentially useful strategy, if used correctly, is the “deep discount”. Clothing retailer Rivers has embraced this method, selling a hotch potch of items such as thongs or business ties for just $2 to get people through the doors, while holding prices on other goods.

Fellow clothing retailer Country Road is winning customers with regular discounts of 30% to 40%. On 19 February, the company announced a sales results increase of 20% to $14.6 million and an 84% leap in profits for the half-year to $10.3 million. Management credited the “trading down” of customers to its brand, rather than more expensive designer clothing, as a major factor in its success.

Pricing to-do list:

1. Reduce the cost of doing business.
2. Acknowledge that customers are nervous about spending.
3. Become obsessed with retaining existing customers.
4. The price of products and services are rarely inelastic. It’s time to rethink your margins.
5. Acknowledge the drop in the Australian dollar and stagnant economic spending, cut costs and set up new pricing models
6. If price rises are unavoidable, ensure there is a clear communications strategy to warn customers of the price hikes. Give customers a chance to lock in at the old prices.
7. Price for economy and value – this can mean price cuts or adding value to existing products and services, ensuring customers are satisfied and will come back
8. Beware of the costs involved in new-fangled loyalty schemes – just as staff annual leave seems to accumulate ferociously, the cost of loyalty programs haa a nasty habit of accumulating and appearing on the balance sheet as liabilities. Try instead more basic loyalty plans, such as “introduce a new customer and you receive 10% off your next bill”. That way your new customers can pay for this small bonus for your existing customers.