Monday, February 11, 2008

An Economic Justification to Raising Your Prices

In the January issue of GrowerTalks, Chris Beytes provided us with some excellent case studies of firms that have recently raised their prices (great job Chris!). I think it merits repeating that the only way in which this makes sense economically is if the company successfully differentiates itself in the mind of the customer in terms of the types of products or services offered and the segment(s) of customers that are being targeted. It is a well-proven fact that customers use five different attributes in making a decision about what products/services to buy and from whom to buy them from – quality, value, service, convenience, and selection.

We economists characterize demand by a concept called the price elasticity of demand which measures the nature and degree of the relationship between changes in the quantity demanded of a good/service and changes in its price. An important relationship to understand is the one between elasticity and total revenue. The demand for a good/service is considered relatively inelastic when the quantity demanded does not change much with the price change. So when the price is raised, the total revenue of the firm increases, and vice versa. What this effectively means is that green industry firms can actually raise their price, and though they might sell fewer units of the product they are selling or the service they are offering, total revenue for the firm still goes up. So, the obvious question is this…how does one go about making their local demand more inelastic? The answer…by making the firm unique and different somehow in terms of quality, value, service, convenience, and selection! That’s why your marketing efforts are so important. They are the key to successful differentiation.

In summary, if your company is successful in differentiating itself from competitors, you are essentially making your firm-level demand more inelastic within your respective trade area and you can subsequently raise your prices and [even though you may sell fewer units] total firm revenue will still increase.

Now I can already hear the objections: “If I raise my price, my customers are going to defect and buy from my competitors.” Let me provide my own testimonial regarding this common objection to raising price. Over the last few years, all (100%) of the green industry firms that I have convinced [after much prompting and counseling] to actually try this have experienced an increase in total firm revenue. Not many, not most…ALL. Interestingly, some even found that per-unit sales actually increased when they increased their prices, which tells me they were pricing their products way too low to begin with. Low prices tend to result in a low quality perception in the mind of the customer and when you raise your prices, sometimes you can influence the price-quality connotation positively.

To bring this to a close, lean manufacturing and shaving costs out the value chain is important as the industry matures, but if we [as an industry] are to make any meaningful increase in our margins and increase profitability, it has to come from the demand side of the equation, whcih means we must obtain higher prices for the products and services we offer!

1 comment:

Anonymous said...

thanks this is just the confidence i need to raise prices