How price sensitive do you think your products and services are? I’ll bet most of you believe you operate in a market that will severely punish anyone who puts their head above the parapet and adopts a premium price structure.
This is an issue that is of concern across nearly all the businesses represented in my client base at the moment. Most have held off price rises because they have seen the hospitality market decline over the immediate past and have felt the full weight of competition breathing down their necks. Over the same period costs have risen steadily, and the net result is a serious erosion of profit margins. So how do you break away from this situation and restore your profits?
Case study — cafe
I first tackled this problem years ago when I had a client who owned a CBD café in Sydney. His business was not as profitable as it should have been and we set about working on the problem. One of his high volume products was coffee — he sold a stack of it — but the profit margin was not as high as I believed it should have been when I took into account the labour intensive nature of quality coffee production.
I told him that he had to review his coffee prices and he nearly had a fit. He argued very strongly that people are extremely price sensitive about coffee prices and that if he put his prices up he would lose all his customers to other cafés in his immediate area. I disagreed, and finally, after some full and frank conversations, convinced him to back my judgement on the matter.
My logic was based on the knowledge of why people buy. Obviously both the price and the quality of products and services are important, but there are other considerations that need to be taken into account when assessing what price the market will bear.
People pay for more than just the product
In my initial assessment of his business I had noticed that my clients’ café was noticeably cleaner and better presented than his competitors, and he and his staff were very affable and had really good rapport with the customers. A business like this could easily degenerate into an impersonal sausage machine of $4 transactions, but they handled their daily routine with an atmosphere of good natured geniality and an air of ‘theatre’ — and most of their competitors didn’t.
This was a while ago; pricing was cheaper then, but the principle is the same. My client argued for a modest price increase — from $2.40 per cup to $2.50. I wanted $2.80. The average price in his area was around $2.45. With much discussion we agreed on a two pronged strategy: A price increase to $2.80, but with a change in coffee cup to a different shaped cup — so the customers would find it difficult to compare apples to apples. We also added larger mugs to the product range, which we priced at $3.50.
Short term loss, longer term solid gain
The day the price rises came into effect a vocal minority of the customers let it be known that they were not happy and many said they would go elsewhere. My client was apoplectic and wanted to reverse the decision, fearing that we had ruined his business. Fortunately, we had agreed to stand firm and review the decision in a month’s time and I reminded him of this.
Customer numbers declined about 5% over the next few weeks but revenue was up by 16% and his profits were measurably higher. My client began to relax and indeed started to talk about putting all his prices up. We drew up a plan to review and increase all his prices over the next 6 months.
The really interesting aspect of the whole exercise was the fact that his customer numbers returned to where they were originally within three weeks of the price rise. Most of the vocal minority came back eventually because they found they received something they were prepared to pay a bit extra for at my client’s — something they didn’t get at the other nearby cafés. A number of them admitted to the staff that they missed the friendly banter, the personal recognition and the scrupulously clean environment.
Don’t assume you can’t increase prices
Most products and services in this industry are not as price sensitive as you might think. If you assume you can’t increase your prices and that assumption is not valid, you will reduce your profits and shoot yourself in the foot. Given that large numbers of hospitality and foodservice businesses are only marginally profitable at present there is a good argument for general price rises right across the industry.
We seem to have a Mexican standoff with each other at present. Most operators want to bump their prices up but no one seems to want to make the first move, for fear that it will lose them their customer base. There is a very persuasive argument that says you are probably better off doing a smaller volume of sales at a higher margin, than doing bulk business for little gain. I’m seeing a lot of businesses that are busy but not making a reasonable profit.
There has been a general reluctance to increase prices in this industry for several years now, meanwhile costs have been steadily increasing. If your business is marginal and the trend is not good, perhaps you should consider changing your direction before you end up where you’re headed?
The secret of increasing prices is presenting your products and services in a manner that makes it difficult to compare pricing with the business down the road. The advertising industry recognised this years ago — its called creating points of difference. Where are you headed right now?