With costs rising right across the board;
How much increase in expenses, can your business absorb, and still be viable?
And at what point do you pass on some or all of these cost increases to your customers?
The main reason why prices fluctuate is simply supply and demand. When demand is soaring, prices go up, and when things are quiet, products and services tend to be discounted.
As I write this blog, (February 2022) I believe we are in a once in a generation situation, where every country and economy is coming out of a slumber state at the same time. For almost two years, the world's economies have regressed due to the impact of Covid-19 through multiple lockdowns. Only now we can see hope, and we're entering a period of boom as everything opens up. Current demand for products and services are being further driven, with pent up demand from those with spare cash to spend. Over these past 2 years, most countries central banks have injected additional cash (printed money) through Quantitative Easing (QE) and given out state handouts, grants, implemented furlough schemes and offered cheap government backed loans to ultimately protect their economies. The high proportion of this extra cash is now sat in either businesses or the general public's banks accounts, awaiting to be spent.
We're in an environment where the high demand and this surplus cash is fuelling high inflation levels across the world's economies. As we are currently seeing, central banks across the world are starting to increase borrowing and interest rates, albeit from lifetime lows, to dampen inflationary pressures.
Today, business owners are experiencing significant prices increases for raw materials, packaging, shipping, warehousing, and distribution, along with an average of 5% annual increase in employee's wages to either retain existing or attract new talent to fill the many job vacancies currently advertised.
We also have double digit percentage increases in gas, electric and oil, insurance premium increases, IT hardware and software subscriptions premiums going up, and higher costs and extended lead times on machinery, equipment along with properties themselves at all time highs. The list just goes on.
As a business we can absorb a certain level of increase, and in the scheme of things a 10% annual increase in say insurance premiums may only affect the bottom line marginally. But let's look how the affect of a 5% increase in the annual wage bill will affect our business financials.
Normally wages are the highest expense in the business and can be around 50% of total expenses. For a small sized SME, with 25 staff, with a £1m annual turnover, wages could be £500,000 per annum. A 5% increase doesn't sound a lot, but in this case that's an extra £25,000 straight off the bottom line. Now if that business has a decent gross margin and control of its expenses, yes they could potentially absorb the extra £25k per annum, however many businesses operate in a highly competitive markets, with high cost of sales and expenses and on average make around 4% net profit (£40,000 per annum). If you take into account all the other costs increases across the business, this could result in the company becoming loss making or be the final nail in the coffin unless they do something about it.
I do understand many business have fixed period supply contracts with their customers and therefore will be tied to a process in respect to reviewing prices.
But for those that can implement a price increase, there's only really two options to ensure your business stays viable. Either;
1. Pass on a portion of the cost increases to your customers,
Or
2. Pass on all of the cost increase to your customers.
I'll tackle the first option first. As a business you may be able to reduce costs elsewhere, so look through your expense lines and drill into everything you buy, the trick here is small costs reductions across the business will compound to a bigger overall saving. Ensure you don't diminish your quality or productivity levels by going to what might seem a cheaper option or supplier. Also look at your processes and particularly where there is idle time of staff or waste of resources. There may be cost benefits from using your resources more efficiently and the ability to shave off production costs and fine tune workflow processes. Once you have done this exercise you can then communicate to your clients sharing how prices increases have affected your business, how you have looked to streamline your business and therefore only passing on part of the increase. The chances are, all your customers will be in the same boat and appreciate the method and approach you have taken, through looking inward into your operations, and then informing them of the new increased costs for your products and services.
In respect to the second option, "passing on all the cost increases to your customers." As a business, you may operate in an extremely competitive market, and to survive you already run a very tight ship, the business is lean with cost management a big part of your daily focus and unfortunately due the external factors as mentioned at the beginning of this piece, there's no viable way your business can absorb the increases being forced on your business. There will be lots of businesses in this same situation and the key point here is how you communicate to your customers and how you go about applying price increases for your products and services.
So,
1. Communicate early and give your customers plenty of time for what will be an impact to them. e.g., give at least a months' notice of price increases.
2. Substantiate and evidence the impact to your business, i.e. fuel costs have gone up from £x to £y. Utilities, Insurance, wages etc are now 10-15% higher. If you're selling B2B the chances are your customers businesses will be experiencing the same issues.
3. Be prepared to lose customers. And don't be inclined to agree concession with some of your customers either. Once you have made a decision, stick to your guns!
On this last point, I know it may feel like the wrong thing to do, potentially lose, or turn away custom. However, much research has been done over the years in respect to the impact of price increases and from my own experience, one point that has always held true in business is;
If you're busy and profitable, doing a good job, your customers are loyal and they understand the value that your business supplies. If you put your prices up by a minimum of 10%, you can afford to lose between 15-30% of your business and still make the same profit than what you were previously. Imagine, getting more for doing less!
You do have to know your numbers and carry out and weigh up different scenarios when applying such an approach. You can only do it once too. I've supported a good number of my clients over the years to structure and communicate price increases. In many cases they have lost minimal or no customers at all and gone on to be more profitable and a sustainable business.
One example from today's news (3rd Feb 2022) regarding Amazon Inc. They've just posted record quarterly sales of $137.4bn and profits of $14.3bn for the last 3 months.
However, Amazon have said they're putting up their Prime subscription service price by 17% from the 25th March 2022 to their existing US customers. btw, they have 200 million subscribers around the globe. In Amazon's statement to the US stock exchange, "this price increase is to offset rising costs" and the report goes on to say, "when they increased prices back in 2018 this didn't impact subscription levels". To be honest, Amazon are good at what they do, and where would their customers go for a similar service level at the value they offer?
So, in times like these, when your business is under costs pressures, don't just fret and wonder, what is we are going to do with all our costs going up, put some time aside, do your homework, agree a plan, and just implement it.