Blog Credit: Kris Blackmon, February 3, 2022 (Services Firms and Price Hikes: 4 Steps to Increase Profits Without Losing Business | NetSuite)
- Inflation is putting pressure on services companies to charge customers more.
- Communicating about price hikes has got to be about alleviating the sting for customers.
- Success tactics include introducing value tiers and premium features and grandfathering longtime clients.
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You did deep pricing research when you started your services company. You balanced your need for revenue against what the market would bear. You researched competitors and broke down the worth of every scrap of value you provide. You analyzed KPIs, crafted marketing messaging, maybe used a freemium or penetration pricing model to undercut the market and get customers fast.
It was enough to get you to your first million or two in annual recurring revenue.
Now your staff has grown, your support and service offerings have gotten more sophisticated and you’ve moved past value pricing as your key advantage. Add in inflation, wage growth, the cost of individual products that make up your service and the advanced business planning and execution costs that come with scaling efforts, and your margins are shrinking. You’ve cut where possible. The only way forward is to raise prices. But by how much, when and on only some services and clients or across the board?
And how will you communicate the increase to customers?
How to Raise Prices Without Losing Customers
Getting this right means not just finding the Goldilocks price, or prices if you have service tiers. It’s also about making sure customers are not resentful about paying more. The key is to communicate how your services contribute to their success. If raising prices isn’t benefiting your customer in some way, no matter how small, then you probably shouldn’t be doing it.
Done right, an increase can give your business much-needed cash flow to continue to expand and improve even further.
Below, we outline some universal metrics, like customer churn and how it can impact gross profit margin. There are additional critical KPIs to track, like customer lifetime value. But the fact is, entire books have been written about how to determine whether, when and by precisely how much you should increase prices. Crunching unit economics, conducting margin-impact analyses, figuring out operating cost impact and taking inflation into account are steps you’ll need to complete.
We’ll offer some high-level advice to get you started on these calculations, as well as ideas for messaging and links to more information on how to communicate increases to services/subscription customers.
1. How to plan to increase services prices
“Customer behavior and market research are crucial for planning a fee increase,” says Chelsea Cohen, co-founder of inventory management provider SoStocked. “As with launching a new product, you should ensure your current cash flow can sustain possible dips from a new price strategy.”
First, estimate expected churn from your rate increase, because raising prices will inevitably cost you some business.
Not all customers are good customers, and not all revenue is worth the effort. Clients that hired you based on price alone tend to consume lots of resources and reject upsell efforts, which may not build your business. There’s a reason services firms sometimes “fire” customers.
If you’ve done a previous increase, then you have an idea of how many accounts you’ll lose by raising prices again. If not, then no matter how savvy you are, it’s a bit of a guessing game. There are companies that claim to use predictive data analysis to calculate expected churn, but their services are expensive and may not be worth the investment. Here’s a peek under their hoods: Most look at your net promoter or customer satisfaction scores and add context by digging into surveys, looking for both positive and negative comments. If you regularly hear gripes about customer service, technical support, product quality and so forth, and you plan to use new revenue from the price increase to improve these areas, then the price hike may be worth it to some detractors. But if customers consistently cite price as a major reason for dissatisfaction, you’ll have a harder time selling them.
James Diel, founder and CEO of contact center technology provider Textel, says that if you increase prices by more than 20%, you run a risk of shedding so many customers that you actually lose revenue, or at best break even.
Keep in mind, though, that churn isn’t always bad. There’s a way to calculate how many customers you can lose and still make more money. It’s all about gross profit margin — the net revenue that you generate from sales minus how much it costs you to provide that service, figured by calculating your cost of goods sold, divided by net revenue.
GPM = Gross sales – COGS / Gross sales
Let’s say you’re a SaaS company that makes $100,000 per month from provisioning, implementing and servicing your software offerings. When you add up what you pay your developers, how much you pay for your infrastructure and what it takes to keep your R&D operations ahead of the game, you find that you’re paying $60,000 per month in COGS. That’s a GPM of 40%.
Now, you raise your prices. Let’s get crazy and say you hike them by 50%, so at your current customer count, you’d make $150,000 per month. The price hike lost you 25% of your customers, meaning that monthly revenue goes down to $112,500. But you plan to pay for improvements in your services and features – including human resources – with that revenue, so your COGS are essentially a wash. What happens to your GPM?
$112,500 – $60,000 / $112,500 = 46.7%
Even though you shed a ton of customers, the revenue lost is still less than the revenue you gained from clients that stayed, so you’re more profitable than before. Plus, new clients will come in at the higher price point.
Bottom line: This calculation is pretty simple if you have the right data, but getting the right data is hard, which is why companies engage those expensive predictive data analysis firms. Note also that all clients that bought based on price and aren’t upsell candidates are not created equal. Those that pay their bills on time each month and don’t consume an excess of resources may be worth some effort to keep onboard.
Cost-Plus vs. Competitor-Based vs. Value-Based Price Optimization Strategies
Do you base your pricing on your COGS plus margin, on value delivered or on market norms? Here’s the 411 on these strategies.
This is the simplest method: What are your direct costs from items like pricer inventory and indirect costs like a more intensive focus around R&D per services delivered, and how much profit do you want to make? Cost-plus contracts are popular with contractors, who are paid for all of a job’s actual expenses plus an additional fee.
Con: Services firms may have difficulty calculating actual costs given the variability of client needs.
|Competitor or competition-based pricing
Here, you’ll use competitors’ rates as the benchmark. After determining the competition’s prices, a company can choose to offer a lower, higher or matched price. In any market, knowing competitors’ pricing is essential to knowing how you’re situated in the market.
Con: Retailers have a much easier time consistently and accurately tracking competitor pricing than services firms, whose offerings are typically not commoditized.
This strategy uses a customer’s perceived value of a product or service as the basis for pricing. For services companies, this is a great method, if you can collect and analyze the right data. Our guide to subscription pricing methods offers two major KPIs to calculate. This strategy can drive higher quality and better service levels.
Con: You’ll need to collect lots of data, from buyer personas to conjoint analysis per service. And you still need to land in the ballpark of your competitors’ prices.
Now, look at previous increases. If this isn’t your first rodeo, you have advantages. Not only do you know which KPIs to look at, but you also have data from past price hikes to inform your decision. How receptive were customers, which objections did they raise, and how did the change impact your bottom line? Did overall revenue increase? Did the added cash flow make you more competitive in the talent market? Did it enable you to make improvements in service or operations? What percentage of clients churned? Which marketing insights did you glean from the experience?
Benchmark against the competition. Unlike companies that sell products, services companies can’t go onto an online marketplace and check out competitors’ pricing. But that shouldn’t excuse you from doing your market research – there are tons of analyst reports out there, and if all else fails, you can always get a meeting from a competing sales rep to demo their service and explain their pricing as if you were a prospective customer. Compare the value they offer against what you provide, so you can be realistic about where a price increase would put your service on that spectrum. If you can raise prices and still come in at or under that bar, that’s ideal. If your current prices are comparable but your services are lacking bells and whistles that your competition boasts, however, raising rates could price you out of the market.
Maybe you’ve developed a new offering, expanded into a new vertical or added features that your competition doesn’t have. In that case, raising prices might be the only way to create a real opportunity for new growth and continued improvement.
Test before you buy. No one says you have to raise prices all at once for your entire customer base. If you’re not sure how a hike will impact customer churn and you sign services contracts, then do rolling increases at renewal time and assess the customer reaction.
If you don’t have annual contracts, you could try A/B testing, in which you offer the same service at two price points, both for existing and prospective customers. Not sure whether to raise prices by 10% or 15%? Try it out with two small groups of clients, and see what happens.
The downsides: Clients may talk in online forums or over a friendly tennis match. If you sell into a tight-knit vertical or sales channel, the odds of this are even higher. If this is your case, then consider adding services to your higher price tier rather than cutting costs – then, at least you can tell people what they’re paying for.
3 Tips for A/B Price Testing
1. Make sure you can get enough data points for analysis. Your marketing team can easily A/B test email subject lines because they likely send hundreds or thousands at a time, and the stakes are low. But if you sign on or renew only a few dozen clients per month, valid statistical analysis is difficult.
2. Don’t use too large a delta. Testing a 20% increase versus a 25% increase is one thing, but a 20% hike versus a 50% hike isn’t a helpful test. Those who see the lower figure will “price anchor” there.
3. Don’t toss in too many permutations. The more variables in the mix, the more random fluctuations will throw you off. Keep it simple.
Ensure you have a way to understand why customers decide to stay or go, such as conducting thorough discovery or exit calls or satisfaction and net promoter surveys.
The point of this exercise is to give you insight into how much you can raise rates before clients flee. You may lose some customers in the testing phase, but better a few now than a quarter of your client base later.
2. Finding a reasonable price increase percentage
Raising prices doesn’t have to mean a blanket percentage rate increase across the board. For example, you could add new pricing tiers or extra features for customers amenable to the new price. This is a way to raise rates for some while controlling COGS for others.
“You can create add-ons to cover the price increase,” says Cohen. “That way, clients who feel they don’t need the upgrade can still stay on your service, while more elite users opt to get the added features at your new cost.”
Maybe customers can continue to pay their existing rates, but they move to a “value” or other new, named tier with fewer features. Clients that want and can afford new features will upgrade.
Keep in mind that premium features don’t have to cost a lot. Maybe those at the top of the food chain receive 24/7 or weekend support when your teams are working anyway, a few extra consulting hours or additional KPI reports from a dashboard you already own.
Conversely, that value tier can involve customers paying the same but your costs going down. If they currently receive 20 consulting hours per week, drop them down to 15. If you’re a digital marketing agency currently providing pay-per-click campaigns, search engine marketing, social media management and website maintenance for $5,000 per month, keep them at the same price but without the social help. This will free your social team up to offer higher-value services like social selling training that you can charge more for in your higher tiers.
How to Set Up a Tiered Pricing Model
The tiered model is popular amongst companies whose customers have varying budgets. The psychological pricing tactics involved include presenting just a few options – and making your standard option especially appealing.
Services businesses have lots of levers to pull. Try raising rates only on the services that give you the smallest margins, so you can increase profit on activities that cost you time without getting you much revenue. Or, raise rates only on your most popular services – since you sell those most, an increase will have a happy impact on the bottom line.
The idea is, either revenue goes up or you’re able to operationalize costs to do more with the same.
Two more tips:
Consider gradual adjustments: If you aren’t in a situation that makes it imperative to act quickly, don’t impose a price increase all at once. Consider going in stages. The downside is that if you implement several increases in a short period of time, customers will see you as inconsistent and wonder when the next price-hike shoe is going to drop.
If you choose to do multiple, incremental increases, separate them by a set time interval and accompany them with good communication. Many services firms use regular annual increases to keep up with rising costs.
Reward the loyal and longtime: Consider a loyalty program for customers that have been with you for the long haul and grandfather them in at the current rate, or give them an option to renew their contracts for some percentage less than your new price. When you show your most loyal customers loyalty in return, they’ll feel valued and you won’t lose that business.
Alternatively, raise prices across the board but offer an exclusive feature or service, such as a dedicated account manager or a free upgrade, that’s available only to clients that have been with you for a certain number of years.
3. How to tell customers about price increases
Now that you’ve done your research and figured out the optimal way to raise prices while providing a good customer experience, you’re ready to communicate the news. If you haven’t already pulled in sales and marketing — which you should have at the beginning — now’s the time.
Avoid changing the terms of your contract in a vacuum. We’ve already talked about A/B testing and other methods to gauge potential churn from a price increase, but here’s when the real one-on-one communications start.
“You should always contact your clients as directly as possible about price increases,” says Diel. “If you have a face-to-face relationship, you need to set a meeting near the end of their cycles and come to them in earnest. Explain why the price increases are happening, and be prepared to back your move up with plenty of justification.”
Most experts agree that the homework you did and the analyses you ran at the start of this process are crucial to structuring your conversations with clients. And be candid. Customers always appreciate transparency.
“We discuss why it’s time for an increase, what value we’ve added and whether revenue growth is representative of that value,” says Dror Zaifman, director of growth marketing at financial technology provider BrainFinance. “We do an audit of their current contracts to determine what is working, what isn’t and what we can do to make it better. We also start with prep work, where we do a lot of research of our competitors. We then share the findings with the clients.”
Never, ever sneak a price increase into your customers’ bills without communication. That’s a guaranteed way to up your churn rate. And remember to make it about value to the customer’s business. Raise prices without explaining some sort of incentive or benefit, and you should expect major pushback. Even if that reason is just staying in line with inflation, clients should understand that due to the market economy, you have to institute a rate hike. Everyone wants to know they’re getting the best deal they can for the benefits they need.
“Raising prices in the recurring revenue model is easy; however, it requires discussion with the clients in innovative ways,” says David Reid, sales director at manufacturing and provisioning firm VEM Group. “Our focus should be on letting the customers realize why we want a price increase and the betterment of the services we provide to them.”
If you’re raising prices but not adding features, you can provide justification in terms of the value you provide and the results you’ve produced for your clients. Even bringing your price in line with market rates is a justification that customers can understand. Clearly, none will be thrilled about the idea of higher prices, but it’s easier to swallow if you can throw some benefits in.
“We point to inflation and the increased cost of doing business along with results of client case studies with our improved services,” says Diel. “Clients understand that the cost of doing business increases, but if you can pair your price increases with proven results from your services, you’ll be more likely to retain them.”
This is where you really, really need your marketing wizards. To that end…
4. How companies raise prices without raising prices
Sounds counterintuitive, but hear us out. Is a price increase accompanied by significant benefits really an increase? Or is it a new price on a new service offering?
At this point, it’s not about you. It’s about their business and how your great new offering can help them grow it.
Use all of your marketing channels to make your messaging clear, cohesive and upbeat. Where possible, communicate the hike one-on-one, with your sales reps sticking to the script that marketing creates. That script should serve as the basis for all communication about the price increase.
Marketing tactics such as account-based marketing (ABM) come in handy here by ensuring that you craft your messaging to resonate with specific individuals at the client company. If your point of contact is the CFO, that requires a different conversation than if it were the sales leader.
If you have so many clients that one-on-one outreach isn’t feasible, first off, good for you! Secondly, that doesn’t excuse you from crafting multiple messages that cover all communication channels and the bases we outline here. Start your messaging well before the increase comes into effect to avoid surprises, and make sure your customer success team is on alert and prepared with marketing’s talking points for when those angry phone calls and emails start coming in.
The bottom line
At some point, you’re going to have to raise prices on your services to remain competitive. No one blames you for that, but customers will blame you if you get the process wrong.
Approach that conversation backed by solid market research and justification based on your business model and growth strategies. Know exactly how and when you’re implementing the price hike and why it makes sense for both your business and your customers. Always communicate the pros of increased service levels, expansion strategies or new features. And never, ever implement a price increase without communicating it very clearly to your client base.
Finally, don’t be surprised, or offended, by churn.
“Be open and understanding if the customer chooses to go another route,” says Diel. “They may come back or they may not, but you’re changing the terms of the agreement, not them, and they have every right to move elsewhere.”
Just think about how you’d want the process to go if you were on the other end of that conversation, and craft your strategy and communication accordingly.
Kris Blackmon is the chief channel officer of industry consultancy JS Group. A veteran of the indirect sales channel, Blackmon has extensive experience in event programming, editorial and content creation, research and analysis and community building. At JS Group, she consults on go-to-market strategies for organizations in the indirect channel.