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The Why and the How of Annual Price Increases

The Why and the How of Annual Price Increases

December 5, 2022

Businesses, particularly smaller ones, often neglect to implement annual increases in their prices, rates or fees: some due to poor management; many in fear of losing clients in a competitive market (as was particularly evident during COVID), and most simply due to a lack of know-how.

The reality is that not implementing annual increases will directly impact your profitability, as your input costs increase each year due to inflation. Maintaining the same prices for goods or services, while the cost of inputs continues to increase, will soon leave you with a substantially reduced profit, especially in a high-inflation environment. Find out here how structured price increases contribute to long-term profitability and how to implement increases without losing clients.

Pricing power is important in business. You want your business to have the ability to raise prices as needed, especially with regard to inflation.”

(Hendrith Vanlon Smith Jr)

It is imperative that businesses increase their fees, rates or product prices annually by at least the rate of inflation, just to keep pace with the ongoing increases in the cost of materials and production.

Inflation is the increase in the cost of goods and services in an economy. It ensures that, year after year, a business pays more and more for the same goods or services it uses in the production of its income. The higher the inflation rate, the higher the increase in your costs each year.

Without related annual price increases on goods or services provided by your business, the inflationary increases in the costs of production will result in lower profits, reduced product or service quality, or even market perceptions that your goods or services are cheap. In addition, the compounding impact of not increasing prices means your business falls progressively further behind in its ability to generate the appropriate and needed levels of profits.

Why do businesses neglect price increases?

There are many reasons why businesses do not increase their rates annually. Some may simply not have the business skills to set or maintain correct pricing. Many business owners are concerned that in a highly competitive market, a price increase will result in lost customers – a fear that was particularly heightened during the COVID years. Most businesses may simply not know how to increase their prices, especially if they have not done so for a few years, and then a substantial increase is required just to return to previous levels of profitability.

Why increases are crucial

In South Africa, the inflation rate is currently at a 13-year high of 7.5% – almost double the average inflation rate of 4.5% in 2021. This means that the cost of producing goods and services has increased by 12% over just two years, and without a related increase in sales prices, your business profits are being eroded at an alarming rate and with every sale.        

Conversely, increasing prices correctly can have a substantial impact on a company’s profitability. Studies quoted in The Harvard Business Review found that improvements in price typically have three to four times the effect on profitability as proportionate increases in volume. In fact, it was noted that a 1% improvement in price, assuming no loss of volume, increases operating profit by 11.1%.

 Top tips for implementing price increases

  • Speak to your accountant about the impact of various price increases on your company’s income, profitability and tax liabilities.
  • Remember to discuss the potential impact of price increases with all staff, from the production team to marketing, sales and the accounts teams.
  • An easy place to start raising prices is to issue quotes for new business at the higher prices.
  • Include an annual price increase clause in all new client contracts and in contracts that are being renewed.
  • For existing clients, ensure that any price increase is communicated clearly, accurately and well in advance.
  • Link the price increase to improving or at least maintaining the value your clients perceive, for example, the use of co-friendly materials, unique expertise in an industry or high-quality products.
  • When implementing a price increase, consider adding extra value to a client, such as a free consultation, free deliveries or improved packaging or wrapping.
  • Once a price increase has been finalised, update all relevant sales documents, website pages, POS systems and the like.

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