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Should You Raise Your Prices? Great question!

by Tom Morton

In the past year your health expenses have increased dramatically, your fuel bills are up, your workers comp insurance is through the roof, and your employees haven't had a pay raise in over a year. Your net profit is down and you want to increase your prices, but worry you'll lose customers if you do.With this tight economy, you feel you must hang on to every customer you have.

Or do you?

There is an old saying in the HVAC industry "No one ever went broke by raising prices." Great theory, but tough to prove.

Another saying "For every 1% you increase your prices you can lose 2% of your customers, and still come out ahead on the bottom line."

Being an engineer who loves numbers, measures everything, and thinks in charts and graphs, I decided to see if this saying is really true.

As I started the calculations, some things were obvious. The size of the company doesn't matter as we're dealing in percentages. So it doesn't matter if a company has $1 million, $10 million or $20 million in sales, the formulas will work.

What isn't so obvious is that overhead and net profit don't affect the calculations, if you assume that overhead dollars won't change if you lower your sales volume. I also assumed that all customers are equal in that they all buy the same amount at the same gross profit.

Net profit is before interest and taxes and is calculated by deducting overhead from gross profit. By running several calculations, you find a constant relationship between gross profit percentage, price increase percentage and the ratio of lost customers to price increase.

So you'll find these relationships:

Total % = Gross Profit (GP) % + Price Increase (PI) %.

Ratio = Ratio of Lost Customers % to Price Increase %.

A simple formula emerges:

Ratio = 100/(GP% + PI %)

Using this formula, we derived the figures that appear in Table 1.

Almost everyone could raise their prices 10% and not lose 20% of their customers. Most would not lose any.

For those who like to see things in a graph, the same figures are plotted in Chart 1.

How do you use the formula or charts? Follow this procedure:

• Determine your current GP %.

• Add to this the price increase you want to try, and go to the chart to find the ratio.

For example, if your gross profit percentage is 30% and you want to try a price increase of 10%, your Total % is 40%. From the chart, at 40%, your Ratio is 2.5. This means you can lose 2.5 times the 10% price increase, or 25% of your customers and still make the same net profit that you're currently making.

So What?
The saying that you can lose 2% of your customers for every 1% price increase and still make the same net profit holds true only when your gross profit percent and price increase percent totals to 50%.

For example, if your gross profit is 40%, you can raise your prices 10%. If you lose 20% of your customers, you'll still make the exact same net profit dollars.

Another example: If your service department gross profit is 60%, and you increase prices by 15%, this gives you a total of 60% + 15% = 75%. From the chart, the ratio is 1.333. This means that a 15% price increase will allow you to lose 20% of your customers (15% x 1.333 = 20%) and still make the same net profit dollars.

I've heard contractors say "If I raise my prices 15%, I'll lose half my customers." It's hard to believe, but in some cases you can actually produce more net profit dollars.

There is an old saying in the HVAC industry "No one ever went broke by raising prices." Great theory, but tough to prove.

Should You Increase Your Prices?
If we were in a true commodity business, raising prices even 1% would drive off 100% of your customers. But we're not in a commodity business. In most markets the difference in price for a three-ton, 10-SEER condensing unit and coil change-out, between the highest price in town and the lowest, is a 2: 1 ratio or even higher.

You know your market better than I do and must make the call, but my knowledge of contractors around the country tells me that almost everyone could raise their prices 10% and not lose 20% of their customers. Most would not lose any.

But even if they did lose 20% of their customers, contractors would still make more net profit dollars. And, after all, why are we in business — to have more customers or to make more net profit dollars?

Please don't think I'm promoting fewer customers as a good business plan. What I'm saying is try a price increase of 5% or 10% and measure how many customers you lose. I believe you'll lose very few if any, and even if you do lose a few, you'll be way ahead on net profit dollars and doing less work.

Tom Morton is with Texas Furnace LLC, Houston, TX, a manufacturer of gas furnaces. Morton has 36 years of experience in the HVAC industry and has worked at the manufacturer, distributor, and contractor level. He spent 28 of those years at Lennox Industries. He can be reached at 713/466-1504 by phone or by email at [email protected].

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