From the early days of computing, there has been a subset of users who think that software should be free. “Most of you steal your software,” Bill Gates charged in his famous 1976 Letter to Hobbyists. “Who cares if the people who work on it get paid?”
Gates’ point was that someone needs to foot the bill for the costs of software creation or there will be no software. He won that debate, but more recently the divide has been over business strategy rather than ethics. The prevailing view is that prices should be kept as low as possible to spur growth. The counter – that raising prices will result in a higher-quality product and take some of the financial pressure off – doesn’t get as much play.
The reality is that most companies are setting their prices too low. There isn’t much danger in at least experimenting with raising prices.
The benefits of raising prices
A price hike is the most efficient way to boost profits. A study by Andreas Hinterhuber found that a 5 percent boost in prices leads to a 22 percent improvement in operating profits. But cutting SG&A expenses by 5 percent only increases profits by 5 percent.
A McKinsey & Co. study also found that if the Global 1200 raised prices by 1 percent that it would boost profits by 11 percent.
The benefits of raising prices go beyond merely financial. By setting prices higher you are alerting the market that you are not taking part in a race to the bottom to sell your services at the lowest possible price. This communicates to your customers that quality and service will be secondary and that you are selling a commodity.
By contrast, raising prices telegraphs the idea that you are focusing on quality. You are willing to lose some customers to focus on the ones who are willing to pay more for a better experience. This can occur on a micro level too. I know a consultant who was in such high demand that he was constantly traveling and wearing himself out. He was surprised when I suggested he raise his prices. But doing so meant that he was able to do less work for the same or even more money. This creates a virtuous cycle in which consumers believe they are getting quality and your company (or in his case, a sole proprietor) works hard to meet their expectations. It becomes a self-fulfilling prophecy.
The fear of raising prices
My friend’s objection was a common one. We all fear that if we raise prices, our customers will revolt and leave en masse. But that almost never happens. Most customers are sanguine about absorbing a small price increase if they’re happy with the service.
For instance, Netflix has raised its prices in the past and though some users complained and growth did slow a bit, the company didn’t lose customers. One reason is that the price hike – from $9.99 a month to $10.99 a month for the standard tier – wasn’t very big. Consumers could rationalize that that extra dollar was a small price to pay for 24/7 on-demand high-quality content.
If your customer feedback and data show that your customers believe they are getting value, then you can probably get away with a price increase. Other “green flags” are if your customers tell you how cheap you are, if your sales team doesn’t have to discount often or if you know that your customers are getting a high ROI off your product/service.
Another way to rationalize a price increase is to note that inflation has been rising lately. In 2017, inflation rose 2.1 percent year over year and the rate is projected to be 2 percent for 2019 and 2020. If you’re not increasing prices then you are experiencing a de facto price decrease by leaving them as they are.
When in doubt, test
The best way to figure out if you can get away with a price increase is just to do it. Sure, you will lose some customers, but if 100 percent of your customers are satisfied with your current prices, that means that you are charging too little. It’s like the person who hosts parties and remarks that they always made just the perfect amount because there was nothing left – what that really means is that if the host made a bit more, people would probably eat it.
If you’re scared to implement price increases across the board though, test them with some new customers. Or you could test two different price increases (or three or whatever) and find the optimum amount that maximizes both retention and profits.
One caveat: You can take the idea of raising prices too far. Not everyone is cut out to be the Rolls-Royce of their category. Pricing isn’t binary though; you can straddle the line between premium and mainstream. A great example of a sophisticated pricing strategy is Apple. With a $999 price tag, the iPhone XS is one of the most expensive smartphones on the market. But you can also buy an entry-level MacBook Air for $999, which is a reasonable price for a model with that capability and form factor. Apple draws a lot of criticism for its high-end pricing, but it’s also a trillion-dollar company.
Consider adding some complexity to your pricing too. If you’ve already created some demand, then resist the culture of underpricing. When in doubt, assume that your prices are too low.