In this blog post, we will cover how to know when it’s time to raise your prices, the two methods to use to determine your new prices, and the best practices around communicating price changes to your customers.
How to Know When You Should Raise Your Prices
To see that it’s time for a price increase, you need a strong financial foundation. Your books have to be clean enough to show changes in your costs, revenue, and margins on individual product categories. If your chart of accounts is messy, this guide from our bookkeepers will help you clean it up.
The need for a price increase will typically show up at the gross margin level for a particular product type. If you’re selling a variety of products, you should have an income account for each type and a corresponding cost of goods sold column that together allow you to calculate gross margin per product category.
For example, if you look at just your egg category you may see that the income is staying the same but the cost of goods sold is increasing, leading to a decreasing gross margin.
After you identify a decreasing gross margin, ask why it’s happening. In the case of eggs, is it because of an increase in feed price, an increase in the cost of labor, or, if you resell eggs, an increase in the cost of wholesale eggs?
Once you’ve noticed the decreasing gross margin and identified the culprit, it’s time to take action to bring the margin back up. Before raising prices, look at your costs:
- Can you negotiate with your egg supplier for a lower price by committing to a longer contract or more flats per month?
- Can you purchase in bulk from your feed supplier, or look for a new one?
However, if the reason for your decreasing margins is something like inflation that cannot be managed through costs, you need to think about changing your prices. It’s not fair to you or your business to just swallow the long-term costs of inflation forever.
Choosing a New Price
Now that you’ve decided that changing your price is the way to fix your decreasing gross margin, you need to set the new price. There is both a science and an art to determining prices.
The scientific method is based on simple math.
- Determine the gross margin you need.
- Do the math to calculate what the new price needs to be based on current cost per unit and the margin you are aiming for.
Ex. You are buying eggs wholesale to resell and they cost $3 a carton. Your current margin on eggs is 30% and you need a 35% margin for your budget. To get a 35% margin on that $3 carton of eggs, you need to sell it for $4.62.
The art approach is based on a cost comparison of similar products with similar qualities in your region. This approach looks for the cost that the market can bear. When compiling your cost comparison chart, make sure to compare to actually similar businesses rather than the Walmarts and Krogers of the world.
Ex. You pull together a list of ten other organic, regenerative egg sellers in your region. Each one is selling their eggs for a dollar more than you. This tells you the market can handle a price increase of a dollar.
In practice, the way that you choose your new price is ideally a combination of both approaches. You use the scientific approach to determine the amount of money you need to meet your margin goals and you use price comparisons to make sure the market can bear that increase.
For example, if the math says you need to raise your prices by 75 cents but all the similar businesses around you are charging a dollar more than you, you can go ahead and raise your prices by a dollar.
On the other hand, if science says you need to raise prices by $1 and your competitors are only charging 50 cents more than you, then you need to assess if your customers will be ok with $1 or if there is a way to change costs to make a 50 cent increase work.
Ultimately, you should place more value on the scientific approach and what your business needs to succeed. But, you should also bear in mind the price comparisons and what is happening around you.
Determining Price Changes for Multi-Product Categories
If the gross margin on a category with many products like beef or vegetables is decreasing, it can be more difficult to determine how to raise prices. The correlation between a single product’s price and the overall gross margin is not as straightforward as when the category has just one or two products.
In this instance, you may not want to do an across the board increase, but instead target certain products.
The best way to determine price increases for a category with many products is to look at which items you sell the most and change those prices. You can do this by running a product sales report, then sorting by volume.
Raising prices on the top 20% of items sold will have much more of an impact on gross margin than raising prices on the items performing more poorly. In fact, it may be in your best interest to get rid of the worst performing items as they are likely losing you money on the bottom line.
Once you’ve determined the items that you will increase prices on, you can play around with the prices until you hit your goal target gross margin.
It’s more complicated than raising the price on one product, but the same principles apply when fixing the gross margin for a multi-product category.
How to Communicate Price Changes to Your Customers
Clear communication with your customers is always important, but you don’t always need to announce a price change. The grocery store doesn’t say when their prices are changing. You only need to announce a price change when it will have a significant impact and risks alienating customers.
Situations that warrant an announcement include:
- A storewide price increase of 10% or more
- A 10% or more price increase on any of your top selling items
You don’t need an announcement if you’re doing targeted price increases of just a few percentage points across many products.
Once you have determined that you need to do an announcement, choose who will receive the announcement. You should only tell the people who the price increase applies to. For example, only people who purchase eggs need to know that the price per carton is increasing. Or, if wholesale prices are increasing, only tell your wholesale customers, not your retail customers.
When you create your announcement, be transparent about why you are increasing the prices. Explain the increase in costs whether it be inflation, rising feed costs, or rising wholesale prices. Your customers appreciate knowing why things are going the way that they are.
Finally, offer a grace period before you put the price increase into practice. This is good for your cash and your customer relationships. People may buy more at the original price than they would have otherwise which will increase your short term cash. And, they will feel cared for which will increase trust and positive feelings.
If you need a more detailed guide to creating a price increase announcement, we recommend this one from our friends at Seven Sons.
Price increases are a natural part of running a business. If you need to change your gross margins, prices are the lever you need to move. A change in price can be the difference between a gross margin that lets you pay yourself and yet another year eking by on off-farm income.