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What’s the better inflation strategy, raising prices little by little or all at once?

June 14, 2022, 10:44 AM UTC

Good morning,

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.”


See you tomorrow.

Sheryl Estrada
sheryl.estrada@fortune.com

Upcoming event: Fortune’s inaugural in-person meeting of the CFO Collaborative, presented in partnership with Workday, will take place at Miller Union, Atlanta, on Wednesday, June 22, at 6:30 p.m. The featured speaker for the event will be Clint Watts, senior fellow at the Foreign Policy Research Institute and NBC News National Security Contributor. Watts will share his expertise on cyberterrorism, social media influence and Russian disinformation. If you’re a CFO interested in attending, you can find the registration form here. For further information, please email CFOCollaborative@Fortune.com.

Big deal

New research by King’s College London’s Policy Institute and Business School found that 61% of London workers say they now have hybrid schedules—working from home at least one day a week and from their workplace fewer than five days a week. However, 56% of respondents believe senior management at their company wants more of their staff to come into the workplace more often, while 16% don’t think this is the case, according to the report. About 73% of London workers believe there will never be a return to the previous way of working where most people come to the office five or more days a week. The findings are based on a survey of 2,015 London workers over age 16.  

Courtesy of King’s College London’s Policy Institute and Business School

Going deeper

A new report by Willis Towers Watson (WTW), based on an analysis of proxy disclosures, found CEOs at the largest U.S. corporations saw their total compensation increase at the fastest pace since 2014. "The total pay for CEOs jumped 15.7% in 2021, sharply higher than the 3.2% median increase in 2020," according to the report. WTW also stated it is the largest increase for CEOs since 2014, when total pay increased around 16%. 

Leaderboard

Dennis Cinelli was named the first CFO at Scale AI. Cinelli will oversee strategic finance, accounting and corporate development. He previously led Uber's business and finance teams for six years, serving as VP and global head of strategic finance, supporting Uber’s 2019 IPO and leading the global finance teams for all Uber businesses (Rides, Eat, Freight, etc.). He also spent over a decade at GE, serving as CFO of GE Ventures, and currently sits on Lime’s board of directors.

Sergio Ribeiro Passos was named CFO at Atento S.A. (NYSE: ATTO), a customer relationship services and business process outsourcing company. Passos, 55, replaces Jose Antonio de Sousa Azevedo, who left the company on June 9. Passos has over 24 years of experience as a CFO at different companies within the customer experience sector, including Teleperformance, G4S and Tecnología Bancaria SA. For the past three years, Passos has worked at Atento Brazil as CFO and corporation as FP&A strategy director. Atento will switch from having five regions to three: North America, South America and EMEA. 

Overheard

“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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