SOI: The price is right

Having great products and services doesn’t guarantee growers’ success. Growers must also price them correctly. Even during the best economic times, most customers consider “reasonable price” as the most important factor when they make purchases. To set a “reasonable price,” growers need to know their production costs, their customers’ preferences, what their competitors are charging, the state of the economy, as well as the tangible and intangible benefits they are offering.

Sometimes growers find it necessary to raise prices for their products. For example, a price increase might occur when a grower experiences a major increase in the cost of a key input; or when a grower starts to provide additional services for the product; or the grower is simply overwhelmed by the sales volume from an unexpectedly successful product.

What factors determine how often growers should raise prices? The stage of the product lifecycle, economic environment, inflation rates, production costs, seasonality, weather conditions, consumer trends and many other factors influence the frequency of price increases. Taking the product lifecycle as an example: if a grower has a new innovative product that is at the introduction stage, price can be increased more often because there is not much competition. When the product is at the growth stage however, competitors appear and growers cannot raise prices as frequently. When the economy is thriving and inflation rate is high, growers need to raise prices more often to cover the inflation. These factors can be double-edged swords, though, that could also prevent growers from raising their prices. For example, during economic recessions when many products do not sell well, raising prices runs a very high risk of losing customers. The maturity stage of the product lifecycle is characterized by intensified competition, and as some competitors might go out of business, the remaining competitors contend for their share of a shrinking pie. In this situation, growers might need to actually reduce prices to maintain market share.
 

Questions to ask

Before a grower raises prices, the first crucial step is to develop pricing objectives, that is, what does the price increase aim to achieve? These objectives should be aligned with the grower’s overall marketing, target market, product positioning, and sales strategies.

• Is the goal to increase market share or profit?
• Is customer satisfaction the primary pricing objective?
• Is the higher price used to signal an enhanced image for their products to customers?

Raising prices is not easy as there is always a risk of losing some customers. If the goal of raising prices is to increase market share or profit, growers need to know how sensitive their customers are to prices. A higher price often indicates lower sales volume. However, growers may generate more total revenue and/or profit with lower sales volume at the higher price; it depends on how sensitive the customers are to price increases. If customers are not very sensitive, growers may be better off at a higher price with somewhat decreased sales volume.

Growers can calculate the ratio between percentage change in quantity demanded and percentage change in price to decide how sensitive customers are to price changes: if the ratio is greater than one, it means customers are very sensitive to price, and raising the price can decrease total revenue; if the ratio is less than one, it means customers are not quite as responsive to price, and raising the price can actually increase total revenue.

If customer satisfaction is the primary pricing objective, or growers want to use higher prices to signal enhanced images for or repositioning their products, then growers need to ask the following questions before raising prices:

Can growers give customers a good reason to pay more for their products?

What benefits can growers offer that are superior to the competitors’ offerings to keep customers from switching to competitors?

Are the customers willing to pay the higher price? Can growers communicate well to customers about the price increase and the added value/features?

Even if some customers are sensitive to price changes, growers can still keep them by identifying the differential benefits or value-added features of their products/services. Growers need to demonstrate the value they provide is increasing more than the price, and their offerings are better than the competitors’ offerings. Growers can identify their differential benefits through focus groups with core customers, distributors, wholesalers and retailers. They also help the grower understand where the products are located in these key stakeholders’ minds relative to competitors’ products.
 

The marketing message

Marketing strategies, target market strategies and sales strategies need to work in tandem with increased prices. If growers need to raise price to a large extent, they might want to pursue a new customer base with greater purchasing power. Expanding the target market to include more upscale customers might be a wise way to make up for the possible loss of price-sensitive customers even if the price increase is moderate. Marketing communications should consistently communicate and remind customers of the reasons why they should choose the particular grower over the competitors. Through marketing communications, growers need to educate customers about the “value” they receive instead of the “money” they spend to justify the higher expenditures due to increased prices. Growers’ sales strategy also needs to be adjusted accordingly. There should not be much deviation from the increased prices, unless specified in pricing policy and for given order volumes. Growers need to educate their sales force about why the increased price reflects the value the growers are delivering and how to communicate the value to customers to avoid downward spiral of negotiating price reductions. If sales promotions are necessary, growers need to make the increased price part of the new sales model by offering lower discount rates.
 

Timing

The best time to raise prices is when there is the least resistance. Growers might find it is easier to raise prices when their customers are satisfied with their products or services. Growers are always recommended to explain the pricing policy upfront through informal communications or in contracts to new or existing customers during the planning stage. With new customers, sharing the price-increasing information at the starting point of the relationship makes it much easier to initiate the conversation in the future. Additionally, growers can let new customers know that they do have a strategic pricing plan instead of raising prices whenever they feel like it. For existing customers, the end of a contract period is often a good time to raise prices without jeopardizing the relationship. Growers need to be honest, let existing customers know how long prices have been at the current low level, explain reasons why a new pricing structure is necessary and share some of the details if necessary. Informing and explaining the price increase in advance gives customers enough time to prepare their budget accordingly and it also provides growers the opportunity to communicate the value of their products to customers.

It is inevitable for growers to raise prices from time to time, and the decision is often a tough one. However, if growers are able to set clear pricing objectives, know their customers well and how much they are willing to pay, identify the differential benefits wanted by their customers, communicate the value of their offerings, and select the right time to raise prices, they can minimize the negative reactions from customers and actually boost profits.

Chengyan Yue holds the Todd and Barbara Bachman Endowed Chair in Horticultural Marketing, Associate Professor at the Department of Horticultural Science and Department of Applied Economics at University of Minnesota.