The Importance of Passing on the Rising Cost of Raw Materials

Impact of Rising Inflation on Businesses

With inflation running at its highest level for forty years, it’s absolutely vital that businesses fully understand the impact of increased costs on their own businesses. Ever since the financial meltdown in 2008, we have lived with extremely low interest rates and extremely low rates of inflation, allowing many businesses to maintain fairly constant selling prices, only increasing them marginally year on year.

However, for a number of global reasons, inflation in the UK is on the rise quite rapidly. The cost of utilities is perhaps the single greatest contributor to rising prices – pretty much everything we do is in some way linked to the cost of energy. For manufacturers and hauliers in particular, this has perhaps a more profound effect, although nearly all sectors of commerce will be affected.

Importance of Passing on the Rising Cost of Raw Materials for Business Owners

The difficulty for most businesses is striking the right balance between passing on some of those costs without losing customers. Having experienced reasonably stable prices for the past decade, significantly increased selling prices will no doubt be a shock to some. That said, with the current rate of inflation, it would be virtually impossible for most businesses to absorb increased costs and still trade profitably.

We’ve set out below our top tips for dealing with the current issues arising directly from today’s inflationary pressures.

Key positives:

  • Ensure that you have all of the relevant costing information available before deciding on what to increase selling prices by. This is not just the current increase in costs that you are facing, but also what the likely impact of those additional costs will be over the next 6 – 12 months. No customers like to pay more, so when you do increase your costs make sure its sufficient to carry you through for the foreseeable future. Will your suppliers’ costs increase again during the next 6- 12 months – will your employees seek an increase in salaries – will you need to source elsewhere at a higher cost because of supply chain issues?
  • Explain to your customers why it is necessary for you to pass on a cost increase. Most businesses are currently experiencing similar problems, so they will be well aware of the issues that you are facing. Be factual and clear about why it is necessary to increase your costs, but also in a way that appears somewhat personal to your customers. Try to avoid the blame game – simply confine your explanations to the true reasons.
  • Discounts and loyalty bonuses. Invariably, when you raise prices, there will be some very price conscious customers that will look elsewhere – that simply is unavoidable. However, for the more important customers, those that contribute most to your profits, consider introducing discounts and or loyalty bonuses when certain targets have been met. If your costs have risen by say 5% then by passing on a 7% increase but giving away say a 2% discount over a specified amount of sales, will still leave you covering your increased costs.
  • Is it possible to source your products/services elsewhere at lower prices? This is probably the most difficult issue to address at this time, given the current problems with global supply chains.

Negatives to avoid:

  • Don’t increase prices without first having prepared for this. Ensure that not only have you prepared a detailed explanation when questioned by your customers, but that you have also communicated the reasoning behind the increase policy to all of your staff as well – especially the sales team and those that have front line exposure to your customers. Your business needs to be seen as a united entity.
  • Do not rely upon one price increase a year. By only looking at increasing your prices annually, you will lack the flexibility to react to rapid changes in utility and supplier costs. Additionally, a 12% increase is more likely to be questioned by your customers rather than if you had applied two at 6%.
  • Do not under cost the amount that you need to increase prices by. Most business owners have a fear that by increasing prices, they will upset their customers. There is some merit to that argument, but if increased costs to you are not passed on, then all that will happen is that eventually your margins will be eroded with the consequent pressures on cash flow and solvency. As we mention above, as long as you explain fully the reasons why it is necessary for you to pass on increased costs, then, the majority of your customers, whilst perhaps not totally liking it, will certainly understand, After all, they themselves are no doubt facing similar issues.

The fundamental issue here, is fully understanding your costs and how increases in certain of those impact your business. To try and stay ahead of the competition, ideally you take the most recent performance and transfer the key data to a simple spreadsheet. That way you can then model your views on how you perceive your suppliers’ costs to you working out over the next 6 – 12 months by factoring in different levels of cost increase.