225: How to Determine When to Raise Rates and When to Absorb Costs
225: How to Determine When to Raise Rates and When to Absorb Costs
with Michele Williams
As a business owner, one of the biggest challenges you face is managing your pricing strategy in response to fluctuating costs. Pricing is a crucial element that can determine the success or failure of a company. On the podcast today we will explore how to manage this in your business.
Topics Mentioned:
Cost management
Brand promise
Pricing structure
Strategy
Listen to the Episode
Setting the right price for products or services is essential to ensure profitability, but sometimes external factors can lead to higher costs that may require a company to make tough decisions. Whether it's an increase in raw material prices, higher labor costs, or unexpected supply chain disruptions, the pressure to adjust prices or absorb higher costs can be overwhelming.
In this podcast, we will explore these two options and the factors to consider when making a decision regarding increased pricing or absorption of cost overruns.
Let’s start with adjusting pricing.
When you begin to incur higher costs as a business owner, one viable option is to adjust pricing accordingly. Increasing the price of products or services can help offset the additional expenses.
If you can deploy this option successfully, your business will maintain profitability and reinforce its brand value as a premium service provider all while improving cash flow. This is a win for your business.
However, adjusting pricing can have negative consequences as well. For example, customers may be unwilling to pay the higher price, which could result in a decrease in sales volume. Additionally, competitors may take advantage of the higher price and offer their products or services at a lower cost, which could lead to decreased demand. Finally, a sudden increase in pricing could have a negative effect on your brand perception if not handled with care. Customers and potential customers could see the change as opportunistic rather than necessary.
If your company decides to choose this route, I would urge you to consider several factors.
First, analyze the market to determine if customers are willing to pay the higher price. Understanding how your competition is pricing is a great way to start your research.
Second, consider the long-term impact of the price increase on customer loyalty and brand reputation. Instead of only considering the present, considering the long-term impact of the decision is important as well.
Finally, consider the impact on profitability, including any potential changes in sales volume and cost structure. Understanding your current financials and knowing the key factors that drive revenue and profit will allow you to successfully model the impact of the potential change.
Okay, now let’s jump into your second option: Absorbing Higher Costs and Reducing Profitability
When facing higher costs, you have the option to absorb the additional expenses and reduce profitability. This can be a difficult decision, as it may lead to short-term losses, but can lead to long-term benefits.
By absorbing the higher costs, your business may be able to maintain customer loyalty and avoid negative impacts on brand reputation.
Additionally, by maintaining a competitive price, you may be able to gain market share from competitors.
It sounds great on the surface but hear me when I say - there is a downside to this as well.
You must consider the impact this decision will have on your profitability. Once you understand this, you must also consider how your business uses profit.
If you find yourself dipping into profit often for ‘additional expenses’, I would urge you to consider a further analysis on your current financial situation before you determine if this is the right course of action for your company.
Oftentimes, absorbing the costs leads to financial strain and an unfair distribution of costs across your offers.
Here are a few things you can do to help negate some of the impact of cost absorption:
attempt to negotiate better prices with suppliers
reduce marketing expenses
optimize your supply chain to reduce transportation costs
A third option when costs begin to rise is a combination of the two pricing strategies above. There is a sweet spot for every business which might mean a minimal increase in pricing along with internal expense reduction strategies to mitigate loss of profitability.
Adjusting pricing, absorbing higher costs and reducing profitability, or a combination of the two are 3 options that you as a business owner have when facing external factors that increase expenses. All 3 options have advantages and disadvantages, and the decision should be based on a careful analysis of the market, customer behavior, and cost structure.
Ultimately, the key to success is finding the right balance between pricing and cost management to ensure long-term sustainability, profitability and alignment with the business’ long term goals.
I would love to help you with financial understanding. You can check out the courses at www.scarletthreadconsulting.com and you can sign up for a Discovery Call to get on my calendar. Don’t let the fear or the lack of understanding your financials keep you stuck. Be proactive in understanding your profits, because making a profit doesn’t happen by accident.
Key Thoughts:
Setting the right price for products or services is essential to ensure profitability, but sometimes external factors can lead to higher costs that may require a company to make tough decisions. Michele (1:03)
When you begin to incur higher costs as a business owner, one viable option is to adjust pricing accordingly. Increasing the price of products or services can help offset the additional expenses. Michele (1:59)
When facing higher costs, you have the option to absorb the additional expenses and reduce profitability. This can be a difficult decision, as it may lead to short-term losses, but can lead to long-term benefits. Michele (3:59)
There is a sweet spot for every business which might mean a minimal increase in pricing along with internal expense reduction strategies to mitigate loss of profitability. Michele (5:25)
Contact Michele:
Facebook: Scarlet Thread Consulting
Instagram: @ScarletThreadATL