Managing costs without raising prices

A price hike to keep up with inflation may actually create more profit for the retailer. How? An item sold for $2 at wholesale nets 20 cents for a retailer who sells at a 10% markup. But a $2.10 wholesale item nets a retailer 21 cents at the same markup. If the retailer’s overall costs such as labor, shipping, marketing and other products remain static, that extra penny of margin can flow to the bottom line.

But with rising product costs and consumers worried about their jobs, marking up the price of goods becomes a delicate business. The smart way for the retailer to do it is to raise prices a little bit here, a little bit there over time so that the consumer doesn’t have one big sticker shock. In order to do that, the retailer has to absorb some of the pain in the short run and eventually pass it on down. And frankly, the manufacturers are trying to absorb pain too because they don not want to be the one that’s raising prices when their competitors aren’t.

How much exactly is a little bit? In the past, most retailers have not known how to quantify the point at which price increases start cutting into demand. Now, business scholars are trying to work out more robust models to determine how much a price should be increased. A good way to gauge the market is to test several different prices at once ideally in different stores and see consumers’ response. This is a way to hedge against future changes in the market by enabling the retailer to develop a model to test how consumers will react to future price increases.

Hoch suggests that retailers try to promote sales in a product area in which prices have not increased. At the moment, prices of electronics and clothing have not risen, but food and energy have. For grocers a prime choice is to emphasize their private-label goods. Grocers typically put more emphasis on their store brands during an inflationary period as a way to offer the customer a better deal without cutting into their own margins. At the same time, pushing the private label keeps the pressure on manufacturers of nationally branded goods to keep their own price increases in check.

Retailers can try also to cut prices in an important category as a way to boost market share, as Costco does by selling gas at a relatively low price. Others have cut prices as an opportunity for running promotions or special sales, recognising that with their customers facing an inflationary crunch, it might be an opportune time to run some deep discounts as a way to try to capture some volume.

Even specialty retailers who can’t make shifts between products quite so easily may find they can reposition their products to an extent. Auto dealers who pitch the notion that now is a good time to buy a big vehicle because the discount will save customers more than enough money to compensate for the extra fuel costs over four or five years. It is crafting and putting the best face on the value statement that you are making.

Other strategies for succeeding in an inflationary environment may require some counter intuitive thinking. While companies typically slash sales and marketing budgets during tough times, some studies have suggested that they would do better to turn up the advertising volume.

Those that do not cut back tend to have much bigger returns for their marketing spend in economic downturns than during times of prosperity. And that’s a real surprise, because you would think during prosperity, people have money to spend and you are more likely to get a return for any of your marketing investment.