Fair price increases: A comment to William Poundstone

Over at Iterative Path, William Poundstone answers the question of whether cost increases are relevant to price increases, and whether brands should always use moments when their input prices jump to pass them along to consumers?

Poundstone draws on behavioral economics research to deliver an answer that says yes, provided the rationale for the cost increase can be communicated as “fair” to consumers.

(Behavioral economists) found that the public did not automatically reject any price increase as unfair. In particular, the public was willing to accept price increases when the seller was passing on his own increased costs.

It’s therefore a sound psychological strategy for a company experiencing commodity cost increases to use that to justify a price increase. Of course, it’s necessary to communicate the reason through signage, ads, or other means.

The core piece of advice here is good, but there are many practical questions from the company’s perspective. How to communicate price increases? Rolling out a sophisticated marketing campaign is costly. When is it worth it? What kind of price increase requires one? Working on these campaigns will take time away from other marketing efforts to introduce new features and products. Isn’t there a better way to do this besides an official marketing campaign?

Here’s an idea: What if companies made some of their costs more transparent? Full transparency would be unwise; disclosing valuable information to competitors and potentially raising new gripes from consumers once they realized a company’s exact profit margins. No one is suggesting anything that silly. Take companies that operate in environments where 1) one of their major commodity costs is dictated by an open global market price that is constantly fluctuating and 2) that make their money primarily through volume, not margin. Think fuel for airplanes or beef for fast food companies.

What if every fast food restaurant devoted a small place on their menu board to communicate a message like, “The cost of beef has increased 40 percent in the last year, but our burgers prices has risen less than 5 percent.” These numbers are made up, obviously.

These messages could be rotated on an regular basis. A real-time beef price quote similar to a stock ticker would be unhelpful. Quarterly updates might be the appropriate interval. Prices won’t always rise. In some years, they will fall. Possibly dramatically. Here companies would face a dilemma. Should they say the year-over-year price fell 30 percent, but their burger still costs $4? Or should they take a longer time frame and communicate price increases over, say, the past 5 years? These sorts of decisions are contingent on customer expectations and reactions.

The basic point is that rather than having companies coordinate separate communication about commodity prices at moments of price hikes, wouldn’t a better strategy be to integrate market commodity costs into a communication strategy more generally? Companies might be able to better justify their price hikes, and in the interim periods of time, show customers the benefits they are getting from price stability.

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  • http://twitter.com/alex_north Alex Bone

    I remember back in 2009 a few gas UK suppliers made a big effort to explain to consumers why their gas prices were increasing due to the additional costs being passed on to them as retailers. However when these supply costs were reduced in 2010 some suppliers didn’t pass those additional savings on to customers and made additional profits because of it.

    It will be interesting to see what companies do when VAT goes up in January 2011. Will they pass on the cost to consumers and if so will they do so with as much fanfare as when they implemented price reductions due to the previous VAT reduction.