The current inflation rate is 7.5% and trending the wrong way. Since you probably already don’t charge enough, what’s your plan now?
You might think that a rude and presumptuous opener, but it’s intended as a tough-love reality check for which you’ll thank me later. Because no business owner has experienced such a spike in inflation since Carter tossed the White House keys to Reagan and “The Jeffersons” replaced “All in the Family” on TV. That was more than 40 years ago when inflation was double today’s rate.
Those facts are why we’re going to discuss the impact of inflation on your pricing strategy. Wait! What? You do have one of those, don’t you? I’ll give you a minute.
The U.S. Bureau of Labor and Statistics uses the Consumer Pricing Index (CPI) to calculate the inflation rate. This calculation is driven by the price of a basket of goods that includes food and beverages, housing, furniture, apparel, transportation, medical, even toys and recreation. Sounds like stuff small businesses sell, doesn’t it?
All things considered, inflation is actually a good thing. If you don’t have it, you’re either balancing on that razor’s edge called pricing equilibrium (like Brigadoon, it pops out of the mist for a day every 100 years), or you’re tipping into deflation. As my inflation/deflation mentor, the legendary Gary Shilling taught me, the only thing worse than a whole lot of inflation is a little bit of deflation.
And just as evil is easier to leverage than good, deflation is harder to control than inflation. Consequently, ever since Michael Jackson’s “Thriller” album was released, the Fed’s stated monetary policies have been designed to maintain a mild inflationary condition, somewhere in the quiet neighborhood of 2%.
For decades, nothing happened in that neighborhood to make the news or put a lot of pressure on your business. But today, 7.5% inflation IS the economic news. Consumers can watch it in the price of peas between weekly trips to the store. And it’s taking your breath away with every updated price for new inventory and services. Since the marketplace doesn’t care whose fault it is, as a small business owner you have to deal with the dangerous reality in front of you: rising inflation, trending the wrong way.
Speaking of going the wrong way. With 2% inflation, your business can mosey down that one-way street called “No Strategy” as long as equity and credit hold out. But with 7.5% inflation and no pricing strategy, you’re racing down that road the wrong way, hell-bent-for-leather, in the dark, in the fog, with no lights and your eyes closed. Somebody call 9-1-1.
In an online poll recently, we asked small business owners this question: “Two months into the year, how is inflation impacting your business?” Over half of our folks reported feeling cost/price pressure. If you’re one of those, remember: if you aren’t raising prices when costs go up, your business is in jeopardy.
One-third of our respondents allowed that inflation wasn’t impacting them. It’s possible that they’re that mythical unicorn, a business impervious to economic reality. However, it’s more likely that they’re just in denial. If you couldn’t answer my first question, you might be in this group. But don’t worry, grasshopper, we can fix this.
Back to my second question: What’s your pricing strategy? Don’t get excited – this is 4th-grade math.
A pricing strategy starts with one number: your monthly/quarterly/annual operating expenses (Opex), which is handy because that total doubles as your minimum gross profit goal – the cash you need. The actual Gross Profit Number (GPN) you produce is what’s left over after subtracting cost-of-goods-sold (COGS) from sales revenue (collected). And GPN relevance happens when it’s applied against Opex. If a red number results, we could have a missing pricing strategy.
Your pricing strategy is armed by your actual Gross Profit Percentage (GPP), which arises from GPN divided by revenue (R). Here are those formulas with sample numbers:
- GPN: (R) $150,000 – $98,000 (COGS) = $52,000 actual
- GPP: (GPN) $52,000 ÷ $150,000 (R) = 34.7% actual
If Opex is $52,000, you broke even. If 34.7% GPP won’t accomplish your business goals (profitability/growth/competitiveness), just apply the percentage you need to your pricing strategy and go to market.
Here are responses to three laments you’re likely to make about troublesome competitive pricing:
- “How long can they maintain those price levels?” Maybe they can’t. It’s possible that competitor doesn’t have a pricing strategy. Outlast them with yours.
- “I can’t raise prices, they’re already beating me.” It might be because that competitor has a pricing strategy based on their numbers. Get busy and catch up.
- “But we do a better job taking care of customers.” If that’s true, you have to make sure customers know and believe it. This is where sales strategy supports pricing strategy. The customers you want will pay more for value, even the perceived kind. But even as customers are dealing with high inflation everywhere else, you still have to reinforce and re-sell your value proposition and relevance.
A pricing strategy based on Gross Profit targets makes operating your business easier (especially during rising inflation), because you’ve established in advance the parameters you must achieve to survive and thrive. All you have to do is identify the impact of inflation (up or down), apply the adjusted GPP to your pricing strategy, and execute.
Finally, there’s one more group from our poll: about 10% said inflation was actually helping them increase margins. Obviously, those are the business owners who’ve been reading my stuff since Clinton tossed the keys to Bush, Fed Chairman Greenspan began his fourth term, and Brad was still with Jen. Just sayin’ …
Write this on a rock … With rising inflation, you’re not only justified in raising prices, you must. But be sure that action is based on a pricing strategy informed by your actual and projected numbers.