Your current customers will never be excited about paying more. But that’s not why raising prices is so difficult.
Instead, poor planning is to blame: Companies neglect to plan a price increase until there’s a financial squeeze or, for the thirtieth time, a customer confides that, “You know, you really ought to charge more.”
What typically follows is a hasty price bump that’s detached from product value and communicated incoherently. To raise prices effectively, you need a strategy that limits risks—and maximizes rewards—of a price increase.
What’s at stake: The exponential impact of a price increase
Many focus on the risks of a price increase: What if you lose customers? What if it’s harder to close sales or generate leads? But the risks of not increasing prices may be equally large—or larger.
A fixed pricing structure not only reduces potential revenue—and, therefore, the money available to invest back into the product—but also impacts perception: Increasingly, customers will see your product as the “cheap” option.
Over time, the potential gain (or loss) in revenue can have an exponential impact. An oft-cited McKinsey report on the S&P 1500 suggests that a 1% increase in price can yield an 8% increase in profits:
That impact outpaces other business changes:
Pricing right is the fastest and most effective way for managers to increase profits [. . .] a price rise of 1 percent, if volumes remained stable, would generate an 8 percent increase in operating profits (Exhibit 1)—an impact nearly 50 percent greater than that of a 1 percent fall in variable costs [. . .] and more than three times greater than the impact of a 1 percent increase in volume.
A third study shows the potential impact of more aggressive price increases: A 5% price rise increased profitability by 22%, more than equivalent changes to other “tools of operational management”:
If a 1% price rise can increase profits by 8–11% and a 5% rise increase profits by 20%, what about a 10% increase? Or 20%? When do returns diminish?
How much can you expect to increase prices?
The answer, of course, depends on your product and buyer (including which buyer among your many). Research comparing price increases to consumer happiness shows an unsurprising trend: the greater the price increase, the greater the impact on customer happiness.
The lesson, as Price Intelligently points out, is not that price increases are bad but that incremental rises—thoughtfully planned, effectively communicated—reduce the risk that you’ll upset loyal customers.
One reason companies mistakenly make a big jump? A low historical price.
The starting point for every price increase
Every proposed price increase is relative to the old one. The contrast between the two impacts consumer perception. Applied more broadly, this principle is known as anchoring.
Anchoring is often used in pricing pages that pitch several options, with the highest option serving as an “anchor” to make the others seem more reasonable:
For price increases, the anchor is the past price. And a low starting price limits your ability to raise it—even if you charge far less than your competitors.
If you anchor people at a low price and raise it later, then no one will see it as getting new value. They’ll see it as gouging.
You will lose the customers you win when you try to raise prices because they will have been acquired on faulty premises.
You can catch up with competitors who charge more, but you may need to do so over time. The challenge is most acute for companies with a freemium model: Users expect to pay $0, and starting to charge them—even a nominal amount—requires clearing a high psychological hurdle.
In addition to below-market pricing, there are other signs that it may be time to increase your rates.
5 signs that it’s time to raise prices
1. Six months have passed.
Price Intelligently recommends one to two price changes each year:
The companies we’ve seen with the most success with revenue and adoption are reviewing pricing at least once per quarter and making tweaks or changes every 6 to 9 months.
Not every “pricing” change involves a straightforward increase: You can expand or remove pricing tiers, reduce or eliminate discounts, or make other changes, as detailed later.
2. You’ve added new features that consumers value.
New features should increase the perceived value of your product. As you roll out new features—and, in turn, more value—your pricing should keep pace.
As OpenView’s Kyle Poyar explains:
When you invest in creating new features and driving more usage of your product, it creates an opportunity to extract some of that added value in the form of higher prices.
Feature value should be determined based on consumer usage and feedback, not a company’s perception (or how much they’ve sunk into development). Customers pay more to get more value, not to increase your profits.
3. Everyone signs up.
New customers can help determine whether current customers would tolerate a price increase.
As Justin Gray writes, a 100% close rate isn’t cause for celebration—it means you’re not charging enough, especially if there’s no pushback or negotiation on pricing throughout the sales process.
If customers are surprised—even embarrassed—by how little you charge, you should charge more. For his consulting work, Karl Sakas targets a 60% close rate. He’s used price increases to bring that rate down from 80%:
During coaching sales calls, I’m seeing a somewhat lower close rate than before—in line with my 60% target, and less than the 80% I was seeing before. This confirms that I was under-charging. (If the close rate fell below 50%, I’d have over-reached on the price increase.)
4. You create ROI well beyond what you charge.
Successful price increases depend on matching cost and value. If you know, for instance, that your software saves a company hundreds of hours of technical labor—but costs just $49 per month—you can make a strong case for a price increase.
OpenView suggests that SaaS companies can capture 10–20% of their economic value, a baseline figure of what you may be able to charge if you can demonstrate ROI clearly.
5. You need the revenue.
This is the worst-case scenario: You need to reverse-engineer a consumer benefit to meet business goals. It’s also one of the most common scenarios.
Because the starting point is inverted—you’re making changes based on a company need not a consumer benefit—be exceedingly cautious with the scope of the price increase and how you communicate it.
Transparency is often the best policy—such as when Rad Power Bikes announced a price increase due to a 25% rise in import tariffs—but consumers are less interested in your problems than those you solve for them.
Ultimately, price increases have a broad impact, not just for consumers but throughout your company.
The company-wide impact—and unexpected benefits—of raising prices
Even within your company, higher prices can be a stressor. They may:
- Reduce close rates for sales staff, even if those reduced rates are desirable.
- Make it harder for marketing teams to hit lead targets.
- Temporarily reduce revenue, which small companies may not survive.
Yet an announcement of forthcoming price increases can have unexpected benefits:
- Existing customers are motivated to upgrade or expand their relationship before the change takes place—higher prices add urgency to subscription upgrades and renewals.
- Current leads are motivated to purchase now.
Regular, well-communicated price increases can serve as a slow burn of urgency—every price has a half-life, and the product will always be cheaper this year than the next. (Some companies, Salesforce included, build annual price increases into their service-level agreements, often in the range of 5–7%.)
For agencies or consultants with limited hours to sell, a price increase can replace older customers with new ones who are happy to pay a higher rate. That’s exactly what Sakas experienced:
As year-end approached, I created a special offer for current clients: If they pre-paid for coaching in 2018 before the end of 2017, they’d keep the old rate (dating back to late 2015) for those pre-paid months in 2018, and then they’d pay the higher monthly price after that.
Nearly everyone opted to pre-pay at least a couple months, and a couple pre-paid an entire year.
The clients who didn’t pre-pay were typically ones who weren’t maximizing their coaching support. During the process, I’d recommended they switch to on-demand support (albeit at a less-responsive SLA, since they weren’t making the same commitment).
This dropoff created slots for new coaching clients at the higher price point, which I’ve since filled.
Sakas also noted that, for some clients, spending the extra money in the current calendar year allowed them to claim a tax deduction that effectively discounted the new price by 45–60%.
Whatever you do, don’t be Netflix.
Case study: Netflix’s “lost year” and a shot at redemption
In 2011, Netflix screwed up. Their well-chronicled debacle briefly split their nascent streaming service from the “cash cow” of DVD delivery. The separation of services effectively raised prices for consumers by 60%.
That poorly planned price increase cost Netflix 800,000 subscribers and plunged their stock price by 77% over four months. The failure resulted from several mistakes:
- CEO Reed Hastings ignored others’ advice.
- Netflix mistook a consumer preference for streaming content for a willingness to eliminate a DVD-based option.
- The changes—and subsequent clarifications—were poorly communicated.
Netflix has since increased prices to far less outrage on several occasions, including last week. Every price change still makes headlines, but the narrative has shifted.
Instead of price increases being reported as cash-grabs or attempts to shove consumers into the future, they’re explained as necessary investments in the consumer experience.
Take, for example, Netflix’s statement about their most recent increase:
We change pricing from time to time as we continue investing in great entertainment and improving the overall Netflix experience for the benefit of our members.
Media outlets have covered the price increase exactly as Netflix wants. The write-ups are pseudo-advertisements, showcasing the most popular programs and reinforcing Netflix’s commitment to consumers:
The lesson was hard-learned but learned nonetheless. Here’s how to skip the painful part and get it right the first time.
The process of raising prices for existing customers
A solid process for increasing prices limits risk. If you own the project, and someone should, ”your job is to hedge as much risk as you possibly can going into a live test.”
Price Intelligently’s process for changing prices spans several weeks:
Below, we’ve combined their process with others that support well-planned, well-executed price increases.
1. Conduct initial research
Research your past price increases. What happened when you did? How many subscribers or repeat buyers did you lose? If lifetime value rose and customer acquisition costs decreased, Jeanne Hopkins argues, you probably got it right.
Historical research suggests what to repeat or avoid, and helps you gauge consumer expectations—years of single-digit prices increases followed by a double-digit rise, for example, may not go over well.
Compare yourself to competitors. Will a price increase move you into a new tier? Are you a mid-range provider that’s trying to get into the high-end market? You’ll need to adjust your value proposition and communicate that shift appropriately. (See Step 4.)
On the flip side: Are you the value option? A price increase may motivate consumers to consider newly price-competitive alternatives.
Ask the right questions. Dan Turchin, a VP of Growth Strategy at BigPanda, takes an open-ended approach to consumer research when preparing for a price increase:
We’re trying to have enough conversations with customers to get feedback on how they associate value with BigPanda and how to translate that into the most simple, transparent, logical way to consume the value.
Those conversations may come from product advocates in Slack groups or via customer surveys. In addition to open-ended responses, you can conduct quantitative research on price sensitivity.
Determine the price sensitivity. Price sensitivity is
a measure of the impact of price points on consumer purchasing behaviors, or in other words, it’s the percentage of sales you will lose or gain at any particular price point.
Because consumers are poor judges of how much they’re willing to pay—as they’re poor estimators of why they make decisions— there are two primary ways to gauge price sensitivity:
1. Price Laddering. On a scale from 1 to 10, customers rate their willingness to buy a product at a particular price. If they answer below a 7 or 8, the price is lowered, and they’re asked the same question again.
While the process can identify a price point at which consumers say they’re likely to buy, it can also introduce errors: Respondents may view the exercise as negotiation and suggest they’re willing to pay less than they actually are.
2. Van Westendorp Price Sensitivity Meter. Respondents are asked to price a product, with each answer having one of four implications:
1. At what price would you consider the product to be so expensive that you would not consider buying it? (Too expensive)
2. At what price would you consider the product to be priced so low that you would feel the quality couldn’t be very good? (Too cheap)
3. At what price would you consider the product starting to get expensive, so that it is not out of the question, but you would have to give some thought to buying it? (Expensive/High Side)
4. At what price would you consider the product to be a bargain—a great buy for the money? (Cheap/Good Value)
The resulting data charts potential price points:
The Vanwestendorp Price Meter, unlike laddering, also reveals the price point at which consumers may view your product as cheap—where brand equity begins to erode.
Whichever method you choose, gather price sensitivity data for different cohorts—your enterprise SaaS clients may have a lower sensitivity to changes than your small business clients, or the structure of your changes (e.g. user limit) may affect one group significantly more than another.
Once you’ve done the research, you can work on your strategy.
2. Develop a strategy
Your pricing strategy identifies which pricing levers you plan to pull and by how much. Initial research— on the product features consumers value most and what they’re willing to pay for them— should help guide the conversation.
If you’re simply increasing the sticker price, the guiding principle is to match value to cost. Finding that balance is easier if you have data on the ROI from your services; failing that, use qualitative responses and price sensitivity research.
As detailed earlier, however, there are other, indirect ways to raise prices:
- Increase restrictions on a freemium or free-trial version. The New York Times has reduced the monthly number of free articles available to consumers from 20 to 10 to 5, essentially creating a new paid tier for readers of more than 5 articles.
- Shift benefits from one tier to another. Removing benefits from existing subscribers (by shifting them to a higher-priced tier) is risky but, nonetheless, an option. It may be easier to do if an entry-level tier has an exceptionally low price point or a feature gets a massive upgrade.
- Use a new feature to create a new tier. Just created an API? That benefit alone may be strong enough to create a premium tier that offers unlimited access.
- Reduce or remove discounts. There’s often a gap between the list price, invoice price, and pocket price. Reducing or removing discounts that are costly but not influential can passively increase prices.
The most common strategy for managing price increases for current customers is grandfathering. It was the choice of nearly half of SaaS companies surveyed by Price Intelligently:
Still, it represents a “common practice” more than a “best practice.” Too often, grandfathering is the preferred solution because it solves an internal problem—a failure to plan and communicate a price change effectively.
Better alternatives involve an element of grandfathering but, over time, align price and value:
- Limited access. Grandfathered customers don’t get access to new features. This strategy has a shelf life—without access to product upgrades, you won’t be able to add value.
- Discounted upgrade. Current customers get a discount if they upgrade. The discount may apply for a matter of months or indefinitely. The latter option has the same shortcomings as standard grandfathering (while reducing revenue loss somewhat).
- Delayed upgrade. Current customers avoid a price increase for a period of time. For companies with annual contracts, this makes sense—consumers keep the current price for the life of their contract, and the renewal aligns them with the new pricing.
Rather than settling on a single option, you can also provide customers a choice:
For instance, they could stay at their current plan at a higher rate, or choose to downgrade plans and keep the rate they’re paying today, or if they commit within 30 days they could get 10% off a better plan than they have now. This takes some of the sting off and puts the customer in the driver’s seat.
(The value of choice—even between two imperfect options—is not insignificant. A choice of meal options was essential to morale during polar expeditions.)
3. Get qualitative and quantitative feedback
Once you’ve settled on your strategy—which aspects you’ll change, by how much, and how you’ll manage current customers—you can estimate its potential impact by running the numbers and floating the plan with a group of consumer advisors.
Run the numbers. Finding out how the changes will affect your customers, Zendesk learned, is tricky if you have usage-based pricing.
In 2010, Zendesk rolled out a price increase that tripled costs for some clients. But cost wasn’t the only concern: The change in plan structure left clients feeling coerced into annual (rather than monthly or quarterly) billing plans. That suspicion compounded difficulties.
When commenting on the fallout to TechCrunch, Zendesk CEO Mikkel Svane cited reasons that could’ve been persuasive as an advance rationale but appeared defensive as an ex-post-facto justification:
This is the first time EVER that we have increased pricing. But we have added new functionality to the service for every week for the last two and a half years.
And today we’re launching a lot more functionality for knowledge base and community support [. . .] Zendesk is investing heavily in new features and our customers will continue to experience great things with Zendesk.
We will deliver on our promise. Are we the cheapest show in town? No. But we do think that we have an excellent offering for almost every budget starting at $9 per agent seat. And we do offer to grandfather our existing customers for one additional year at their current price point with all of their current functionality grandfathered indefinitely.
Consider how edge cases may affect perceptions of fairness: If an increase won’t kick in until an annual contract renewal comes due, what about those whose contracts renew next month?
That’s one reason to announce price increases before they take effect: An announcement that renewal fees will go up in six months gives everyone time to budget accordingly.
Talk with your insiders. Run the new pricing plans by your customers to assess their reaction. Price Intelligently, which recommends talking with at least 20 current customers, emphasizes the importance of asking the right questions:
Remember that this is a sanity check, as customers individually will have an incentive to say prices are too high. In that light, don’t ask open ended questions like, “what do you think?” Ask questions that get to a point about your most worrisome issues (does this make sense, what questions do you have, etc.)
If you’ve gotten something terribly wrong, they’ll tell you—and you’ll be able to fix it before it’s too late. You may also learn which aspects of the price increase are the most persuasive or important to communicate.
4. Create a communication plan
This was a common refrain: Be transparent about why the price is going up. If you feel compelled to obscure the reason—or if it takes thousand-word essays and charts to justify it—that’s a sign you don’t have a strong case.
Still, focusing on key points can help justify an increase:
- The length of time since the last price increase;
- The value you’ve added to your product or service during that time;
- If you have service limitations (e.g. consulting hours), the increase in demand.
“Prepare to overcommunicate,” Sakas cautioned. “I gave current coaching clients ~5 months’ notice [. . .] My goal was to honor existing commitments and reward loyalty—but also so current clients wouldn’t be surprised later.”
Be clear about how the changes will affect current customers, especially if you plan to grandfather some in.
5. Gather and adjust based on post-launch feedback
Finally, ask for feedback. If you’ve failed to consider a customer segment or are likely to face backlash, the sooner you can learn about it—and devise a solution—the better.
One way to measure feedback is to monitor consumer behavior. A decrease in time-to-purchase or onboarding flows, Turchin explained, signals a successful price increase:
We measure sentiment on pricing mostly by the adoption cycle – how quickly a customer gets into production and how quickly the deployment grows. We’re definitely seeing onboarding times and time to incremental purchase go down.
After you complete a price-increase cycle, keep going. Review your pricing every couple of months. Not every review of pricing will mandate an increase, but every review will help keep your prices aligned with your value. The longer you ignore it, the harder it becomes to realign the two.
“Anyone can raise prices,” writes Patrick Campbell. “But raising prices and customer satisfaction requires a strong understanding of your customers’ valued features and willingness to pay, which you get from your research.”
Increasing prices is terrifying if you don’t know what your consumers value most or how much they value it.
But ignoring pricing isn’t an option. The longer you delay a justified price increase, the worse your options become—it will take longer to align product price and consumer value, or you’ll take greater risk to try to do so more quickly.
Even if you face an urgent need to raise prices, remember: Thorough research and clear communication are equally essential.
Source: Conversion XL