Part 2 – Managing a Minimum Wage Rate Increase – Increasing Prices, Sales Volume & Cutting Costs

By Rick Howard | January 12, 2016 | Comments Off on Part 2 – Managing a Minimum Wage Rate Increase – Increasing Prices, Sales Volume & Cutting Costs

Part 2 –

Managing a Minimum Wage Rate Increase – Increasing Prices, Sales Volume, Cutting Prices, etc.

This is the second post in a series of posts relating to dealing with an increase in a minimum wage rate. The first post dealt with estimating the impact that a wage rate increase would have on your business. Make sure you have read and understood that discussion since this article builds upon its assumptions.

In the previous article, using the small business example and the Oregon proposed Minimum Wage Rate increases, we estimated the financial impact on the example business would be about $198,000 over the 3-year implementation period.

The primary actions owners and managers will consider to negate or minimize the adverse impact of a wage increase are:

  • Increasing Prices,
  • Increasing Sales Volume, &
  • Cutting Costs (Including Labor).

INCREASING PRICES –

The first consideration should be increasing the product and/or service prices. How much would you have to increase prices to off-set the wage rate increase? In our example, you would need to increase prices 7.5% the first year, 5.7% the second year, and 5.7% the third year (cumulative 18.9% price increase over a 3-year period).

This is your first consideration because it gets instant results since it impacts existing customer sales. If you increase prices tomorrow by 5%, tomorrow’s sales will be 5% higher. That is, until the price increase changes a customer’s purchase decision. Customers’ level of price sensitivity depends on many things. Price sensitivity for your product/service in your market is something you will need a firm grasp of.

Note that this estimate assumes that everything else will stay the same… Specifically, it assumes your customer volume will remain even, the costs for your materials, and supplies and overhead expenses will remain even.  Assumptions are dangerous, and in this case, the assumptions are ridiculous! Why? All businesses in your area will be implementing wage rate increases, and will be increasing their prices. These businesses will include your suppliers and service providers.

Just know that you will be increasing your prices…  a lot. There is a domino affect that you are in the middle of.

INCREASING SALES VOLUME  –

The next area of consideration is increasing your business’ sales volume.  Obtaining new customers is a more difficult way to increase sales than raising prices, but increasing volume is a better solution in the long term. After all, you can’t raise prices all the time or you won’t have any customers left.

This choice as a solution comes with challenges. While raising prices gets instant results, generating new sales volume is a slower process. Desiring to increase customer count and sales volume isn’t a new consideration that comes only with addressing wage rate increase. This is something most business owners and managers try to implement every year…  every week even.

Dollar increases in sales volume doesn’t have as an effective impact to your bottom line as increasing prices.

  • When you increase prices, each new dollar, or 100%, goes towards net profits.
  • In contrast, when you increase “sales volume”, the related variable costs will also increase. In our example, variable costs are 63%. For new sales volume, only 37% would go to the bottom line.

Using the same example business base figures, if management chose to off-set ALL the adverse financial impact without any price increase, and by only increasing sales volume, it would have to increase sales volume by 104.6 % (3-year cumulative rate). That’s more than doubling sales volume in a 3-year period!

This option as a single business strategy is an impossible solution.

INCREASING PRICES AND SALES VOLUME  –

A better solution is a combination of increasing prices up to your customers’/markets’ price sensitivity, and then increasing sales volume to make up the remaining difference. The sales volume example we previously reviewed has been changed implementing a 5% per year price increase first, and then the resulting sales volume necessary to address the remaining amount would be 13.6%

To better illustrate the two components of Pricing and Volume, a more detail breakdown of the above estimate is illustrated below:

 

DECREASING COSTS  –

We all like to think we don’t have any excess costs, but you will need to reach a new level of cost control. It will be even more challenging when your vendors are most likely increasing their prices.

When cutting costs, not all costs are equal. Some cost reductions will be a one time savings. If you are able to reduce an on-going expense, the savings will be repeated and have a greater impact.

One of the cost categories to consider is labor. An increased minimum wage rate means you need greater value and higher production per hour. Review training and supervision processes to see how you can bring new employees to a higher performance level more quickly. Giving new employees extra time to learn and develop may be a luxury you can no longer afford.

EXCEL SPREADSHEET –

We have provided an Excel spreadsheet to help you compute the financial impact of the wage increase to your business. Here is a link to the page with the Excel spreadsheet. [ LINK ]

PLEASE COMMENT BELOW –

What managing and business strategies do you believe will be the most effective in surviving a large Minimum Wage Rate Increase? What additional ideas do you have to help your business survive?

 

Series Links…

 

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