What should be checked before raising prices?
Compare customer fairness, contribution margins, acceptable sales loss and competitor responses before increasing prices. Separate the calculation from the assumptions.
What should be checked before a price increase?
When raising prices, whether customers understand the reason is more important than the amount of increase. An increase that reflects a rise in costs is generally accepted, but an increase that takes advantage of a surge in demand is criticized as unfair. Calculate the amount of sales loss your product's margins can cover before raising the price, and compare side-by-side alternatives other than raising list prices.
Which price increases will customers accept and which will they rebel against?
A classic study examining perceptions of fairness (Kahneman, Knetsch, Thaler, 1986) asked residents of Toronto and Vancouver, Canada, by telephone in 1984–1985 about several price situations. As wholesale prices rose due to transportation disruptions, 79% of respondents said it was acceptable if grocery stores increased the price of lettuce by that much (101 people). On the other hand, if a hardware store raised the price of a snow shovel from $15 to $20 the day after a heavy snowfall, 82% responded that it was unfair (107 people). Even a grocery chain that charged prices 5% higher in areas with no competing stores was also considered unfair by 76% (101 people).
Researchers explain this as the principle that customers use existing prices as a standard and accept increases when profits are threatened, but view increases that take advantage of changes in demand as unfair. It must be taken into account that the timing and country of the survey are different from our current market.
How much will sales decrease if you raise the price?
A meta-analysis (Bijmolt, van Heerde, Pieters, 2005) combining 1,851 values from 81 price elasticity studies reported an average price elasticity of -2.62. When the price rises by 1%, sales volume decreases by an average of 2.62%. However, this value is mainly measured at the brand level, so it includes customers who move to competing brands, and varies greatly by industry and product.
Therefore, it is more useful to first calculate the amount of sales decline our product can endure rather than the average value. When the contribution margin is m and the increase rate is p, profits are maintained if sales volume decreases by less than p ÷ (m + p).
Sales volume reduction limit at which profits are maintained even after increases
| contribution margin | 3% increase | 5% increase | 10% increase |
|---|---|---|---|
| 20% | 13.0% | 20.0% | 33.3% |
| 40% | 7.0% | 11.1% | 20.0% |
If we substitute the average elasticity as is, a 5% increase would result in a decrease in sales volume of about 13%, which is within the limit for products with a 20% contribution margin, but exceeds the limit for products with a 40% contribution margin. This means that products with higher margins are more susceptible to customer churn.
How can we determine the price sensitivity of our customers?
The closest evidence is your sales history from past price changes. Here, we look at the prices of competitive products and substitutes, as well as the reasons why customers choose our products. Korea Research Institute of Business & Branding investigates customer needs, purchasing processes, competitors and alternative products at Market research/competitive analysis. If you don't have enough records, you can try uploading from one region or one channel first. The procedure for confirming willingness to pay with a small range of tests is the same as New business hypothesis verification.
What alternatives should we compare other than raising the list price?
If the starting point of the price problem is cost, list price is not the only answer. Korea Research Institute of Business & Branding If we translate the method of writing down the conditions, costs, expected effects, risks, and execution order for each alternative side by side in determining the price, it is as follows.
Comparison of price-responsive alternatives
| alternative | suitable conditions | Expected effects | danger |
|---|---|---|---|
| list price increase | Can explain cost increases | Margin recovery immediately | Price-sensitive customer churn |
| Reduce discounts and promotions | Large proportion of discount sales | Actual sales price improved | Temporary decrease in sales |
| Divide by grade | Different customers want different features | Fair value for customers with high willingness to pay | Increased operational complexity |
| Capacity/configuration adjustment | There is demand for small packaging | Maintain mark price | Duty to notify, decline in trust |
| Cost savings | There is waste in processes and work. | Maintain prices and improve margins | Possible decline in quality |
Cost reduction takes time and is often combined with other alternatives. Please review Effects of introducing generative AI to find out how to reduce costs by automating tasks.
What obligations do capacity reductions entail?
In May 2024, the Fair Trade Commission revised the “Notice on Designation of Unfair Consumer Transactions by Business Operators” and designated reducing capacity, etc. without informing consumers as an unfair consumer transaction practice. From August 3, 2024, if the manufacturer of the target item reduces capacity, he or she must notify it on the packaging, on the manufacturer's website, or at the sales location for at least three months from the date of the change. Violation is subject to a fine of 5 million won for the first time and 10 million won for the second time according to the Framework Act on Consumers. If the unit price does not change or the rate of change is 5% or less, it can be excluded from notification.
How should I notify customers of a price increase?
If customers make decisions based on existing prices, informing them in advance of the reason for the increase and when it will be applied sets a new standard. Write down the reasons for the increase in detail, such as raw material costs or logistics costs, and give corporate customers time to discuss according to the contract renewal schedule. It is also helpful to communicate that there will be no change in quality or service with the raise.
What should you watch for after raising prices?
Compare the churn rate, repurchase rate, customer price, number of price inquiries and complaints for several months after the increase using the same criteria as before the increase. Korea Research Institute of Business & Branding considers short-term performance and long-term competitiveness and trust as its core values. When pricing issues become strategic or organizational challenges, Management research and advisory field is where you'll find the lead.
Price increase Frequently asked questions
Would it be better to raise the price significantly all at once or in installments?
There is no right answer. It depends on whether the product is one where customers check the price frequently or has a fixed contract cycle, so calculate the expected churn for both methods together.
Should we put up with it if our competitors don't raise their prices?
First, check whether your competitor’s cost structure and customer base are the same as ours. Products with clear differentiation have the potential to maintain higher prices than competitors.
Does the capacity reduction notification obligation apply to all products?
Manufacturers who produce items that are closely related to daily life as defined by the notice are eligible. Please check the asterisks in the notice to see if our products are eligible.
How should I determine the amount of price increase?
You can determine a reasonable range by using the cost increase as the standard and comparing the sales reduction limit calculated by the contribution margin ratio with the sales records from past price changes.
References
- The American Economic Review, 「Fairness as a Constraint on Profit Seeking: Entitlements in the Market」(Kahneman, Knetsch, Thaler), 1986. https://www.jstor.org/stable/1806070
- Journal of Marketing Research, 「New Empirical Generalizations on the Determinants of Price Elasticity」(Bijmolt, van Heerde, Pieters), 2005. https://doi.org/10.1509/jmkr.42.2.141.62296
- Fair Trade Commission, “Notice on Designation of Unfair Consumer Transactions by Businesses” revised press reference, May 3, 2024. https://www.korea.kr/briefing/pressReleaseView.do?newsId=156628946