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Is it time to think the unthinkable and put your prices up?

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Haydn Rowe - Managing DirectorIs it time to think the unthinkable and put your prices up?

Inflation persists at above 3%. Raw material prices are soaring. VAT has just risen by 2.5%. Exchange rate changes have been large.

The fact is that throughout 2010 the plates have been shifting on your costs, and the awful truth for many businesses is that doing nothing could result in a dramatic loss of profitability.

It's time to review your pricing for 2011.

It's a great time for a refresher on the shocking impact that seemingly small price cuts (or the effect of inflation, raw material prices and exchange rate movements) can have on the viability of your business.

The results may well shock you.

The first table (below) shows that discounting for many businesses can have a devastating impact on bottom line profits - often much more than we would ever believe. Even with seemingly modest reductions.

For example, the table below shows that a business with a 30% gross profit margin that implements a 10% price reduction (either through promotion, negotiation or cost increases that have not been passed on) needs to increase sale volumes by a MASSIVE 50% just to stand still in terms of profit!

Price Table - Discounting

The implications are mind numbing.

Just to maintain last year's profitability you and your people would have to work 50% harder, you may need to drastically increase stock levels, your machinery and equipment have to handle 50% more output - and that's before you consider the potential negative hit on your cashflow.

And you make no more profit. In fact, if you 'only' achieve a 20%, 30% or 40% increase in sales volume you make less money.

What about putting your prices up?

Crazy you may think - especially now.

You can hear your sales people protesting already - "we'll lose customers", "our conversion rate will drop", "you'll go out of business" and "our competitors will have a field day".

But consider this.

Again based on a 30% gross profit margin, if you put your prices up by 10%, you would have to do 25% less before it affected your net profit.

Pricing Table - Increasing Prices

In other words, you could ship or supply 20% fewer products (or services) and you'd actually be better off.

You'd be doing less work and making more money.

And you have to ask what are the chances that 20% of your clients would leave if you are doing a great job and providing excellent value?

The reality is that when we first work with new clients we discover that many undercharge.

And when they muster up enough courage to increase prices, most discover that they keep their clients and continue to win more new clients - because they give great service, excellent value and go that extra mile.

They were always worth more and their clients know that.

I have discussed this issue with CEO's in workshops all over the UK over the last 3 or 4 months. When I ask who has raised prices in the last 12 months, a surprisingly large number say that they have.

And when I ask them if they have lost clients as a result, the answer in the vast majority of cases is a clear and resounding "no" (and we are talking rises here in the order of 5%, 10%, 12% and 15% - way above inflation).

In fact in all cases, the effect has been a dramatic, significant and immediate increase in profitablity, which improves cashflow, boosts reserves and allows investment into the business.

Of course, the effect of not charging what they should would have had the opposite effect - low or no profits, poor cashflow, low reserves and no investment.

Can you see why failing to act could be financial suicide?

For some businesses with the capacity to handle a 40%, 50% or more increase in volumes a price cut could result in enough new sales to increase profit, and could be the right decision.

However, the reality for most businesses is that a price cut or unaddressed 'cost creep' is a recipe for disaster.

Using these tables will help you make much smarter decisions about your prices for 2011, and may help you to understand why it is vital to resist the temptation to make (or allow through cost creep) seemingly minor, but potentially crippling price cuts.

It can be a hard decision to take, but not taking the right decision now could be even harder as the consequences catch up with you.

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