Product pricing is among the most difficult, most important, aspects of running your business. In some cases, it is also among the most neglected. Some businesses will go through the initial process of setting a product’s price and then not review the price for years. If ever.
Why might price list neglect be seen as a sleeping killer? Perhaps you have competitors who have lowered prices and now you are the most expensive. Perhaps costs have increased and your margins have shrunk. Or, years old pricing is now seen as cheap, equating to inferior? While reasons are endless, the impact is the same: Hitting your numbers is gets harder and/or profitability is suffering.
Following is a very narrowly focused example on the impact inflation has.
Let’s say you start out with $100 product. It cost $60 to produce leaving you with a profit margin of $40 or 40%. We will use the US’ average inflation rate of 2.2% (2000 to 2021, Macrotrends).
With unchanged pricing, by 2007 the $40 margin shrinks 25% to $30, due to product cost increases.
By 2013, margin has been cut by half (50%).
At this point you may be thinking, “…nobody goes 13 years without changing prices.” You would be wrong. One global organization I consulted with had gone -14- years without price increases in one of its regions. While 14 years without a price increase is extreme, the general issue is more common than you might expect.
It’s Only 2.2%, Right?
Ignoring 2022/23, this behavior can be insidious as the impact grows slowly, subtly, year to year.
Building on our case study, let’s assume senior management has an initial target of $40,000 based on 1,000 units sold per year.
As product margin erodes, Sales needs to sell 1,328 units to meet the target. By 2013, 1,963 units are needed to hit $40,000/year.
As salespeople know: Management never lets the revenue target remain unchanged year-to-year:).
In this next chart, if product price is increased 2.2% each year to match inflation, profitability is preserved.
These next two charts show impact of Actual inflation without price increases, then with inflation-adjusted price increases. In the first chart, loss of 25% margin happened in 2006, compared to ’07.
Observations
Established Customers (B2B) If you have an established recurring customer base, correcting for price erosion is not easy. Small price adjustments, say 5%, might be absorbed without little grief. Larger adjustments, such as the 14-year example, may need to be negotiated to span several years.
Large price adjustments often trigger a customer’s complete reevaluation of the (your) product being used. If your product’s (or service) is not perceived to have grown appropriate to the new price, you may find they decide to look elsewhere.
Customer budgets represent their own constraints on your ability to make corrections. The larger the customer, the more often budgets are rigidly fixed. Unless you are a high-value or strategic supplier to them, you may find you have no ability to pass along a price increase. You may need to try and get them to plan an increase for next year’s budget.
Food for Thought
Maintaining a price list can require significant effort, requiring several factors be considered. Skipping a year or two can have significant, accumulated downstream impact.
My experience has included software companies with revenue ranging from 10s of millions, to 100s of millions, to billions. While the multi-$B companies had their acts together, I have seen companies in the $10-$250M range completely out of touch with their pricing. If you’ve read this thinking it’s a startup-only issue, don’t be fooled.
Image Credit:
Newspaper Flyer – Patrick Perkins