How Inflation Can Sink Small Businesses
From my experience as a small business consultant, nearly 93% of small businesses today need to increase their prices. This number comes from my own consulting experience, not an official study. Around 7% were keeping their pricing in line with inflation. I consulted for small service business owners invoicing $2,000,000 or less a year. What I found was that many of them gave a price at the start of the contract service period and they forget to set up price increases over the years. They fear losing the client, so they have never given a price increase. Most of the time, they really don’t know how to appropriately send out price increases. This can happen with single service businesses as well. Let’s say you run a carpet cleaning company. You set your price per square foot, and it takes you 5 – 10 years to increase your prices.
Inflation will eat a small business alive!
I’ve also done guest consulting visits with business owners who are invoicing over $2,000,000 a year. It seems they understand the power of inflation to crush thier businesses. They had systems and processes in place to create annual price increase for all clients.
Let’s look at how inflation will devour your profitability over the years using the already tracked Consumer Price Index (CPI) numbers from the last 23 years. This means, the cost to the owner went up each year to provide the same service/product to the customer.
Let’s say you have a service business that invoices monthly. How could inflation and lack of annual price increases affect your profitability if you waited 5 years to increase your prices? I am basing the number below off actual Consumer Price Index (CPI) increase numbers.
In the above table, you can see that over a five-year period, this one account would have increased in cost to the business owner $3,979.80 (All increased costs combined). However, as you know, in the business world we never(rarely) charge our customer things “at cost”. Otherwise, why are we in business?
For this reason, I recommend a minimum of 3% increase each year or the CPI, whichever is higher. This prevents sticker shock and keeps you ahead of actual costs. If we run the same scenario above, the numbers would look like this:
The total lost revenue would be $7,530.54 (all lost revenue combined). Take that revenue that should have been charged, minus the increased costs to the owner and you get your lost income for that period.
Lost Revenue (3% per annum) – Increased Cost (CPI) = Lost Profit
$7,530.54 - $3,979.80 = $3,550.74 lost profit on that account.
Now, think of what $3,550.74 could do in the stock market over 20 years at a conservative 7% return. That comes to $13,740.24 of lost take home pay! That’s just on one account. Imagine if you had 10, 20 or even 30 of these accounts. Slowly the loss potential becomes sickening.
As a side note, selling the price increase becomes exponentially more difficult the longer you wait. Using the above example, if in the 2015 year you approached your customer and explained that the monthly price will go from $5,000 to $5,150 a month, it’s rather easy to swallow. On the other hand, if you wait five years and then approach your customer stating the price will go from $5,000 a month to $5,627.55 it may make your customer look elsewhere for pricing due to the high increase. They have budgets they are working with as well. Many of the larger businesses know to budget for a small increase each year. And so should you!
Remember, remember, remember to set up contracts, processes and procedures to include at the minimum CPI increases each year. I would recommend at least a 3%, or whichever is higher. If you don’t, you will slowly price yourself out of business.