SMEs: should you pass on cost increases to your sales prices in times of inflation?

Are you a CFO of a small to medium-sized company facing a significant increase in costs during this period of high inflation? You may be wondering whether it makes sense to increase your selling prices to offset your expenses and maintain your profitability. This crucial question divides companies. And for good reason, raising prices is not without risk.

In this article, we give you all our advices to adopt an adapted strategy, and to navigate at best in this tumultuous economic period...

‍To raiseor not to raiseselling prices: the dilemma for SMEs in times of inflation

According to figures published by INSEE in February 2023, consumer prices rose by 6.3% and producer prices by 13%. And this is nothing compared to the rising costs of certain raw materials, transport or energy. For example, the price of electricity sold to professionals should increase by 84% in 2023 (without taking into account government aid measures), according to Insee.

As the CFO of a small to medium-sized business, you obviously can't sit back and watch these cost increases seriously threaten your margins. You have two options:

‍Option1: pass on cost increases to your selling prices

You keep control of your margins, but you risk losing customers and damaging your brand image in the long run, especially if the price increase is significant and sudden.

‍Option2: Hold your prices

You protect your customer relationship, but you put your margin at risk, and therefore threaten the profitability of your business.

It is clear that each of these options presents risks. The challenge is to find a balance between increasing your prices sufficiently to preserve your margin, while limiting this price increase as much as possible so as not to impact your sales. 

The results of the quarterly barometer of BPI France and Rexecode, published in February 2023, show that most companies adopt a strategy halfway between option 1 and option 2:

• 61% of VSEs plan to increase their sales prices in 2023
• ⅓ of them plan to reduce their margin this year

‍

‍Clarifyyour strategy before deciding whether or not to raise your prices

In times of inflation, you need more than ever to have a clear positioning and pricing policy. For example, you can opt for a low price positioning to attract a large clientele, or conversely, choose a high price positioning by highlighting products or services with high added value.

How do you determine your strategy? You need to study your market to make informed decisions. Among the parameters to take into account:

• Demand: if it is high, you can obviously afford to increase your prices more than if it is low.
• Competition: if none of your competitors are raising their prices, it is more risky to raise yours.
• Your offering: if your customers' perceived value of your products or services is high, or if you have a strong competitive advantage, your price increase is likely to be better accepted by your customers.

The key indicator to keep in mind is price elasticity. It measures the sensitivity of demand, or the reaction of buyers to price changes. If price elasticity is high, a price change will have a significant impact on demand. Conversely, if price elasticity is low, a price change will have little impact on demand. 

‍Increaseyour sales prices: yes, but not just any old way

If, at the end of this analysis, you decide to pass on your cost increases to your sales prices, make sure you do so wisely. Here are our tips.

‍Increaseits prices in a gradual and segmented manner

The golden rule is to avoid imposing a price increase on your customers too abruptly. You can for example segment your offer, to identify your products or services on which a price increase will be more easily accepted. You can then increase only a part of your prices.

It is also recommended to proceed in stages. Rather than announcing a sudden, across-the-board increase in your prices, opt for gradual increases at several points during the year.

‍Taking care ofyour communication

Communication with your customers is crucial to minimize the impact of your price increase on their loyalty and their perception of your brand.

Here are some tips:

• Communicate in advance of the actual increase in your rates: give your customers time to adapt to the situation and to look for possible alternatives. Don't give them the impression that they are being warned at the last minute.
• Be transparent: prepare your message well and be educational to explain the reasons why you are increasing your prices.
• Highlight the quality of your products and services: to mitigate the impact of the price increase, insist on your added value.
• Listen to your customers and show empathy: be aware of possible reactions and adapt your strategy accordingly.

If you have a B2B activity, it is generally easier to communicate on your price increase, because your customers often have the same issues as you, and have the possibility to pass on your price increase to their customers. 

One last tip: talk about increases in percentages rather than in real value. For example, rather than announcing "+800 euros" on a quote, prefer to indicate "+4%". The psychological effect is generally less, and it is often easier to justify this figure rationally to your customers.

‍Adaptingyour contracts in the face of inflation

It is important to anticipate inflation when negotiating your contracts by including specific clauses and discussing how prices will be revised in the event of inflation.

For example, think about inserting price revision clauses in your quotations or GTCs (General Sales Conditions). They allow to link the price of a contract to an inflation index. Thus, if the inflation index increases, the contract price is automatically revalued accordingly.

Also review your payment terms, to avoid a deterioration in your company's cash flow. For example, it may be a good idea to ask for larger down payments or payments in advance.

In conclusion, the question of whether or not you should pass on cost increases to your selling prices is a complex one and depends on many factors, specific to your company. However, it is essential to think carefully about your pricing strategy and to put in place appropriate mechanisms to adapt your sales policy to inflationary fluctuations.

‍