Raise prices when you have to, or go out of business
Small business owners are reluctant to raise prices, but positive cash flow requires increased prices.
Recently, I read a newspaper article about a 40-year-old family restaurant that suddenly closed. It is hard to second guess that decision from afar, but the owner stated increased costs, increased taxes, and higher wages for the decision to close. I feel bad when a local institution—a landmark—abruptly closes. Perhaps the owner didn’t adjust prices as the costs increased.
Raising prices seems to be feared by small business owners. I have counseled many struggling business owners, and I usually advise them to raise their prices. Most of them don’t, and the reason they give me is that it will scare off their customers and send them directly to the competition. Part of this reasoning is real, but most of this reasoning is irrational.
If a small business owner made a 20 percent increase in their prices all at once, most regular customers will balk and find a different supplier—your competitor. But you have to raise your prices. Costs go up, and that is a fact of life! Your customers are used to price increases. Your customers are astute and they pay attention to the news and the economy. They expect costs to go up. But you can’t do it all at once. Incremental price increases will help to maintain your margins.
Do you ever wonder why gasoline prices at the pump go up the instant something bad happens? You know the scenario: a refinery fire in Texas and prices at the pump go up twenty-five cents per gallon. We all think that the oil company is ripping us off, gouging us because the gas station clearly has two-weeks of supply, and it did not cost that much when they filled their tanks. It is true that the gasoline in their tanks did not cost as much as the next delivery. But they raised the price today to cover the increased cost of the delivery in two weeks—and they are still in business.
As an entrepreneur, we are reluctant to raise consumer prices. But there is a reason for immediate response from all of the gas stations: today’s sales pay for tomorrow’s delivery. You see, it is the profit from your sale today that will allow you to purchase inventory for tomorrow.
Here is a hardware store example. The store has one roll of copper electrical cable that they had on their shelve for 2 months. They bought it for $50, and sell it for $100. That is a pretty good markup. But, when the store goes to reorder the cable, their cost is now $100. Past practice would suggest that they mark this one up to $200 and sell the copper for twice what they paid for, but this will probably put them out of business.
You see, selling the first cable provides a $50 profit. This $50 is needed to replenish the original copper cable, but now the store actually has a $50 deficit because of increased costs from the supplier. This sell-low/buy-high cycle will put the business into serious cash-flow problems—and it will happen fast. If the hardware store immediately raised the first cable to $150, they would have had the $100 profit needed to replenish the original supply. This is what gas stations do, and if they do it and are still in business, then you can adopt their strategy and stay in business too.
You can raise your consumer prices. When your supplier indicates to you a cost increase, you should immediately pass that increase to your customers. And you should do it today, because the profit form your sales today fund your inventory of tomorrow.
Paul J. Werner is an Michigan State University Extension educator from L’Anse, Michigan. You can obtain free business counseling by registering with the MSU Product Center. Werner has many years of experience in small business ownership and entrepreneurship; he and his wife currently own two small businesses in the Upper Peninsula of Michigan.