Is 'Price Hikes = Customers Leaving' True? The 'Price Elasticity' Thinking That Business Owners Must Know in an Era of Rising Interest Rates
Rising long-term interest rates, soaring raw material and labor costs.
As the environment surrounding small and medium-sized enterprises becomes increasingly severe, one of the most difficult decisions a business owner faces is ‘raising product or service prices (price pass-through).’
‘If I raise prices, won’t customers leave and my business disappear?’
Driven by this intense fear, many companies continue to keep prices low while bleeding red ink.
However, as we look at the numbers in our support work, we notice that many business owners misunderstand a basic concept of economics.
That is ‘price elasticity’.
This time, I will provide a framework to logically organize ‘Can my company’s product prices really not be raised?’ without relying on case studies or abstract arguments.
What is ‘price elasticity’ in the first place?
Price elasticity is an indicator that shows ‘how much demand (sales volume/number of customers) changes when the price is changed by 1%.’
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Products with high price elasticity: Common products or services with many substitutes (competitors). If you raise the price by 1%, demand drops sharply.
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Products with low price elasticity: Products or services with unique added value that cannot be replaced elsewhere. Even if you raise the price slightly, demand (number of customers) is unlikely to drop.
The structural problem for many business owners who cannot bring themselves to raise prices is that they assume all their products and services have ‘high price elasticity (if I raise prices, customers will leave).’
‘Two Cognitive Biases’ often encountered in price reviews
In the field of pricing, there are broadly two structural errors occurring.
①: Price elasticity is high, but it is ‘below cost to begin with’
When dealing with products with many competitors and high price elasticity, the business owner’s intuition that ‘raising prices will reduce work’ is correct.
However, when looking at finances and costs, there are endless cases where the unit price is set below cost (the more you make, the more you lose) before even discussing price elasticity.
In this case, what is needed is not just a price hike, but ‘presenting criteria for withdrawing from unprofitable projects’ and ‘negotiations based on objective cost data’.
②: Price elasticity is low, but you are ‘fearfully selling cheap on your own’
This is a case where, despite the quality, facilities, or location provided by the company being overwhelmingly superior to competitors, the low prices from the initial opening or past customs are left as they are.
Essentially, even though it is a product with ‘low price elasticity because it cannot be replaced elsewhere (customers won’t leave even if prices are raised),’ the business owner continues to sell cheaply on their own due to past fear.
‘Three Judgment Axes’ that business owners should review periodically
In this coming era of rising interest rates and high costs,
keeping prices unchanged based only on intuition or fear is synonymous with quietly shortening the lifespan of your company.
Business owners need to periodically redefine their company’s price structure using the following three steps.
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Understanding cost structure and actual profit: Are ‘projects you assume are profitable’ falling into the red due to rising costs?
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Objectifying added value in the market: Is your company’s product ‘something that can be replaced elsewhere (high elasticity)’ or ‘something that cannot be replaced (low elasticity)’?
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Building withdrawal criteria and price negotiation logic:
Instead of negotiating based on emotion, calculate appropriate unit prices based on objective data and clarify the withdrawal line below which you will not go.
Facing the numbers and moving toward self-sustaining management
For a business owner, ‘facing financial statements and costs alone to make the decision to raise prices’ is an extremely lonely and heavy task.
That is precisely why we at Sosei Advisory do not just leave behind a polished proposal and walk away; we work alongside the business owner to restructure the numbers, build the logic for price pass-throughs, and accompany them to the very end of their on-site decision-making process.
If you feel even the slightest sense of discomfort regarding the balance between your company’s prices and its value, why not start by objectively dissecting your current costs and market position?