Don't just raise your prices- here is why

Many companies are confronted with higher costs, and to preserve their margin, they did or planned to increase the prices of their offerings. Long-term contracts in some B2B markets even include an automatic price adjustment based on a predefined inflation metric.

However, most companies don't enjoy an automatic price increase, so they need to raise the price. Tempting and easy as it might seem, just passing the higher costs along is not a good idea. Here is why: first, you should take the opportunity and re-assess your pricing structure strategically. Second, principles of pricing psychology suggest that "charging more for the same" frustrates your customers more than defining a "new normal".

Let's start with strategic pricing. In a very simplistic view, the objective of pricing is to maximize profits. However, my research shows that every firm has more than one pricing objective at any given time, as the following list illustrates.

1.     Profit maximization (long term). Banks offer student accounts with special interest rates to attract this segment when their income increases.

2.     Profit maximization (short term). A shipping company is increasing freight rates by 50% to benefit from a capacity shortage in the market, even if this action hurts its customers' loyalty and satisfaction.

3.     Growth. A TV cable company offers unique subscription plans for new customers to achieve a strong market position within 24 months.

4.     Market share. An international beer company strives for at least 10% of its market share in any national market, which is considered the strategic threshold.

5.     Market stability. A steel distributor does not follow a price reduction by a competitor based on the assumption that it will only be temporary. Customers frequently hate to readjust their inventory valuation.

6.     Price leadership. A no-thrill airline is constantly advertising the lowest fares on any route served.

7.     They are deterring new providers. A professional event technology firm offers rock-bottom quotes to special events to signal its pricing power to potential new entrants.

8.     Positioning. A watch company prices different brands along a predefined, brand-led price corridor.

9.     Resource utilization. An accounting firm offers lower or low fixed rates for work outside the high-demand tax season.

Before you define your new prices, ensure you are clear about your objectives. For example, we have seen that a Swiss grocery chain did not pass on the total cost increase to its customers to gain market share from the competition and observed an increased frequency in their stores.

Some companies are creating totally new offers at new price points. The Swatch Group has launched a new model, "Omega x Swatch Moonwatch" and priced it at 250 Euro, higher than a Swatch but much lower than an Omega.

Of course, there is much more to pricing than defining your objectives. Please watch my LinkedIn Learning Courses on this topic or download my book on Real Impact Marketing.

The second reason why you should not just raise the price is psychology. Let's assume a B2B supplier offers a chemical product for $100 per unit and wants to increase the price by 8%. Psychologically, the buyer perceives this as a loss and might react negatively. As we know from "loss aversion" theory, customers count losses much more heavily than gains. 

The company sells a chemical formula for $100 per unit in the current offer. It delivers twice a week, and the invoice needs to be paid within 30 days. Customers can call the salesperson for any advice and handling questions. Many small customers are unprofitable because they have many questions and order small quantities. Conversely, very large customers often order last-minute, disrupting the firm's workflow.

The current cost increase is 8%, but understanding pricing psychology, the firm avoids just raising the price to $108 per unit. Instead, it creates three offers without changing the chemical formula's core product.

1.     The PREMIUM offer is "much better for much more". The primary purpose of this offer is to give customers more choices and to make the middle offer the most preferred one. The second advantage of introducing an express delivery is to charge customers who order late an extra fee. As a consequence, the customers may either start to plan better, hence reducing the workflow disruptions. Or they are willing to pay 40% more for express delivery, which is very profitable.

2.     The NEW NORMAL offer is "more for a bit more". The price increase must be higher than the costs of the additional services. Most customers should be attracted to this version as it delivers good value for money.

3.     The DISCOUNT offer is "less for less". It serves two primary purposes. First, the customers don't feel forced to pay more, which strains their relationship with the firm. They are offered a choice and will hopefully accept the NEW NORMAL. Second, some customers are not value-buyers but true price-buyers. The supplier can cover the low end of the market by providing a less costly option.

Times of inflation is both a risk and an opportunity. When it comes to pricing, the opportunity is to increase prices and re-assess the whole pricing structure and strategy. By implementing new prices in the market, principles of pricing psychology help firms to improve both profits and customer satisfaction.

Stefan Michel teaches strategy, marketing and pricing at IMD business school. His pricing courses can also be found on LinkedIn Learning and his most recent book, "Real Impact Marketing", is available on Amazon.