Here Comes Inflation – Don’t Raise Prices Quickly

Norm Brodsky in the Street Smarts column of Inc magazine titled How to Prepare Your Business for Inflation shared his absolute confidence that inflation is on its way.  I agree.  Some of his advice for how to handle it was spot-on.  He suggests buying hard assets and, in situations like a lease where you are the buyer, lock in long-term contracts if possible.

However, Norm erred with the following advice.  “Finally, I would try very hard to raise prices, even if it’s just 1 or 2 percent a year. That way, when inflation spikes, you won’t have to hit your customers with a big increase all at once.”

I respectfully disagree.  First you should try using every trick in the book to avoid raising prices.  We had one tactic last week on Shrinking Your Candybar.  There will be more methods to follow.  However, if you absolutely have to raise price, my advice is the opposite of Norm’s.  Hold off raising prices as long as possible, and when you do, make it big so you don’t have to do it again for a while.

There are two big reasons for this.  First, you may recall the blog on “The Effects of Consumers’ Price Expectations on Sellers’ Dynamic Pricing Strategies”.  The article was by Hong Yuan and Song Han and was published in Journal of Marketing Research, Feb 2011.  The important take-away from this perspective is this:

Our customers tend to purchase the same thing over and over.  Their decision-making is on auto-pilot.  However, whenever we raise prices we force them to revisit their purchase decision.  The fewer price increases you use, the fewer times your customers re-think their decisions.  So use fewer price increases to keep more customers.

The second reason I recommend one large price increase over many small increases lies in the graph to the right that describes prospect theory.  In this graph, the axis labeled Losses and Gains represents the price increases and decreases.  The value axis is how much the customer values the increase or decrease.   Notice the curve in the lower left area.  This curve implies the following:

Your customer may dislike (have a negative value) of a 10% price increase by some amount.  Your customer will dislike a 20% price increase more, but not twice as much more.  So one price increase of 20% creates less negative value than two 10% price increases.  Let me say that again in different words, because it’s important.  You will tick off your customer less with one large price increase than with multiple smaller price increases that total the same.

My advice – try very hard to not raise prices.  If you have to, do it less often.  Infrequent larger price increases are better (less painful) than more frequent smaller ones.  As with almost everything in pricing, this is not a hard and fast rule.  You must pay attention to your competition and your customers’ responses.  But given a choice, opt for fewer price increases.

Mark Stiving, Ph.D.