Understanding When to Raise Prices
Having lived in Florida for many years, I have had the opportunity to spend a few days now and then at a major amusement park whose name is likely a household word. At the time of my last visit I was astounded by the admission price!
Shortly after my visit I asked a friend who once worked in marketing for the amusement park how the admission prices were established and was astounded by the answer, as you may be.
My friend confided in me that the park’s practice for several years had been to raise admission prices until they saw the number of admissions drop by 10%, at which point they would leave the admission price in place until admission traffic recovered. They would then wait for a period of six months or so and began the process again.
Reacting just as a remodeler would, I asked what possible relationship there could be between admission prices and the costs of running the park. His simple response; "None".
Days after my discussion with my friend, when my initial shock had worn off, I began to realize that the park was solving a number of potential problems using this method. It also dawned on me that there was something remodelers could learn from the park’s approach.
You will agree with me, I'm certain, that one of the problems the park continuously faces results from overcrowding. They have learned that short of cutting off admissions at a certain level (which they do on occasion), raising prices is an effective way to slow down traffic at the gate.
Another problem the park has to face is that of staffing. If there were wild swings between busy days and slow days, the park management might find itself wasting time and energy hiring and training new people to cover the anticipated large admission days, only to lay them off or assign them to part-time on slow days, possibly risking the loss of their investment in time and energy if those employees quit.
Perhaps with all the experience the park has accumulated running their service business they have realized that they do best when they target and control the volume of service they provide. Under certain economic conditions I'm sure that the park finds that admission falls even without the upward pricing spiral. If such a trend becomes apparent perhaps the park would not be hesitant to lower prices to stimulate gate admissions.
Now let's put our remodeler's caps back on and see what we can learn from the practices of this amusement park. In today’s economic climate as remodelers we might find it necessary to slow down the orders for new work, just as the park finds it necessary to slow down admissions. If we simply decide that we are not taking any more business without considering how we could create less demand for our service, without losing out on profits, just as the park must when they cut off gate admissions on a certain day.
The preferred method of control for the park is to have a pricing strategy that discourages some people from attending, but allows those who are not sensitive to price to attend. If we apply this strategy to the contracting business it might look something like this;
Assume that we normally carry a six-week backlog of work. If that backlog grows to eight weeks we might find ourselves looking for more help, always a difficult issue. To avoid the prospect of having to hire and train more people we could raise our prices by 15% perhaps and see if that creates an alternative solution to our problem.
The desired outcome would be a slight drop in orders that would mean that our backlog starts to shrink. Remodelers who have experimented with this approach often find that raising prices one notch does not accomplish their goal, some have to repeat the process by raising the prices another notch.
The goal is to eventually find the price level at which you can maintain a comfortable backlog of work and avoid the wild fluctuations or run-away growth conditions with their inherent problems. Should conditions change a reversal of the process could stimulate the growth of our backlog as we open the gates again to those customers who are more sensitive to price.
Mike Gorman has been active in the finance and remodeling industries for over 20 years with hands-on experience in carpentry, sales, estimating, supervision and management as well as mortgage financing relating to remodeling, new home building, weatherization and building science. He is active TechKnowledge Systems, located in Miami, FL.
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