What’s the better inflation strategy, raising prices little by little or all at once?
As the U.S. is experiencing the highest level of inflation since 1981, and rising rates are on the horizon, the issue of price increases is still on the table for many companies.
“The Fed is between a rock and a very hard place at this point because we have 8.6% inflation as per the [consumer price index], that’s year over year, and a 1% increase between April and May,” Peter Earle, an economist and research fellow at the American Institute for Economic Research, told me.
So when it comes to price increases, does it make sense to raise them all at once or in increments? Earle says it depends on “what business you’re in, and what particular market you’re in” to determine the frequency of price increases. However, “for the most part, generally speaking, it’s probably a good strategy, to increase prices by small changes, rather than by sudden jumps,” he says.
McDonald’s is a company that intends to go the “little by little” route. “We have the approach that we want to do more frequent increases but at smaller levels,” Head of McDonald’s international business Ian Borden said during the Evercore ISI Consumer and Retail Conference on June 9. “So we try, and I think, generally make sure that we don’t get into doing substantive increases.”
In consumer-facing industries, on both the products and services side, “your costs are fluctuating quite a bit over the course of the year, and you need a way to manage your prices,” Utpal M. Dholakia, professor of marketing at Rice University’s Graduate School of Business, told me. “You cannot keep your prices the same. That is when it makes sense to kind of change prices by small amounts.”
In contrast, you’ll see significant price increases all at once in business-to-business industries like chemicals, manufacturing, and business services, for example, as these companies raise prices once a year or once every six months, Dholakia explains. To maintain your customer relationship, “the price increase should be all at once; it should be announced and explained,” he says.
Hidden price increases and ‘shrinkflation’
Of course, there are myriad ways to raise prices that are completely indirect and hidden, Dholakia says. “In a restaurant example, this would be like selling fewer steaks where the steak has a lower margin and selling more roast chicken or fish dishes because those have much higher margins.”
Another example? Some automotive companies are “making far fewer of their base models, which cost less and are priced less,” he explains. “And they’re making more of their premium models with more packages and different options.” The consumer is paying more because they simply cannot buy the base models, he says. “You don’t change prices at all; you simply change the assortment of the products you’re selling to, in effect, increase price realization,” Dholakia says.
“If I were to consult with a company, my advice to them would be you should never just increase prices,” he says. “Think of all the other ways you can actually make a higher profit, a higher margin without even changing prices at all.”
One method some companies use is “shrinkflation,” Alexander J. MacKay, an economist and assistant professor at Harvard Business School, told me. This is when “firms might reduce the package size, but keep the price the same, with the idea that people will be more likely to buy less at the same price than pay more for the same amount.”
When firms set prices, “they have three different components that are essential to consider—your costs, your consumers, and also your competition,” MacKay says. “Consumers are probably going to react more to price changes if it’s a critical part of their budget, like gas prices, for example,” he says.
Earle says that “businesses have got to be profitable,” so raising prices may be inevitable. “Know your customer and what their likely reaction is to changes,” he says. “I know many businesses are holding off on price increases right now. That’s admirable, and it’s heroic. But after a certain amount of time, operating at a loss is a disservice to everyone—suppliers, vendors and even your customers.”
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Courtesy of King’s College London’s Policy Institute and Business School
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“It’s possible we will go into a recession obviously. There are 50-50 odds now.”
—Morgan Stanley chief James Gorman said at the firm's investors’ panel on Monday, Fortune reported.
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