How do I decide when to absorb cost increases or when to pass them on to consumers?

Recent volatility in commodity inflation poses dilemmas for retailers. While some decide to pass on resulting increases in prices to consumers, others, such as H&M or Primark, are more inclined to absorb higher costs within existing profit margins to maintain prices and preserve market share.

The decision to absorb cost inflation naturally leads to margin shrinkage and is a difficult one to take. However, AlixPartners pricing specialist and vice-president Amit Vedhara says: “Chasing market share is seldom incrementally profitable, but might be justified if economies of scale can be achieved through large enough increases in volume.”

A retailer’s typical instinct is to pass price increases on to the customer and maintain gross margin. Vedhara adds: “This becomes challenging, however, when there is either intense price competition or where an increase would lead to the price crossing an important psychological threshold, such as £9.99.”

In the case of price competition, it is still advisable to pass on increases, even if the item has to be discounted to some customers later, advises Vedhara, pointing out that a partial net increase is better than none. However, if the increase pushes an item above a key price point, Vedhara suggests considering “jumping to the next psychologically important point – for example from £9.99 to £10.99”.

Citing Stanford University research that shows that a price of £10.99 is as, if not more, effective as £10.49 at triggering positive purchase decisions, Vedhara concludes: “There’s equivalent or superior propensity to buy at £10.99, with the added advantage of 50p more margin.”