A skipped increase lowers every later price, while costs keep rising on schedule. Worked over five years, with the volume a lower price keeps.
Skipping one year's price increase costs the increase forgone on every unit sold that year, and again in every following year unless the gap is caught up, because each later increase is applied to a lower base. On an illustrative business with 50,000,000 of revenue, a 30 per cent margin and costs rising 4 per cent a year, skipping one 4 per cent increase costs 1,730,667 of contribution in the first year and 9,373,850 over five years, undiscounted, if it is never recovered, 5.4 times the first year's loss, even after the volume a lower price keeps.
Worked in full in Pricing Strategy by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A price increase is a permanent change to the base. If list prices are raised 4 per cent a year and one year is skipped, every later price is 1 / 1.04 of where it would have been: 3.85 per cent lower, for ever. Costs do not skip the year. Variable cost per unit rises on schedule, so the unit contribution falls by far more than the price, and the shortfall grows each year with the business.
The decision to skip is usually taken for good reasons: a key account under pressure, a competitor holding prices, a sales team that wants a quiet year. It is rarely taken with the five-year number on the table.
| Input | Value |
|---|---|
| Price today | 100.00 |
| Units a year | 500,000 |
| Revenue | 50,000,000 |
| Variable cost per unit today (margin 30.0%) | 70.00 |
| Cost inflation a year | 4.0% |
| Planned price increase a year | 4.0% |
| Price elasticity of demand (illustrative) | -0.5 |
The elasticity says a price 3.85 per cent lower keeps 1.98 per cent more volume. That is generous for a business-to-business product, and it works in favour of skipping.
Step 1, year one at unit level. Planned price 104.00, variable cost 72.80, unit contribution 31.20. With the increase skipped the price stays at 100.00 and the unit contribution is 27.20: a 4.00 move in price is a 12.82 per cent fall in contribution per unit, and the margin drops from 30.0 to 27.2 per cent.
Step 2, year one in money. Planned: 31.20 × 500,000 = 15,600,000. Skipped: 27.20 × 509,902 units = 13,869,333. The cost of the year is 1,730,667.
Step 3, carry the path forward. From year two the increases resume at 4 per cent, applied to 100.00 instead of 104.00.
Price skipped, year t = P0 × 1.04t−1; price planned = P0 × 1.04t
Units skipped = units planned × (price skipped / price planned)elasticity
Cost of the skip, year t = (price skipped − VCt) × units skipped − (price planned − VCt) × units planned
Excel, year t in row r: =(P0*1.04^(t-1)-VC0*1.04^t)*Q0*(1/1.04)^E-(P0*1.04^t-VC0*1.04^t)*Q0
| Year | Planned price | Price after skip | Variable cost | Contribution planned | Contribution after skip | Cost of the skip |
|---|---|---|---|---|---|---|
| 1 | 104.00 | 100.00 | 72.80 | 15,600,000 | 13,869,333 | -1,730,667 |
| 2 | 108.16 | 104.00 | 75.71 | 16,224,000 | 14,424,106 | -1,799,894 |
| 3 | 112.49 | 108.16 | 78.74 | 16,872,960 | 15,001,071 | -1,871,889 |
| 4 | 116.99 | 112.49 | 81.89 | 17,547,878 | 15,601,113 | -1,946,765 |
| 5 | 121.67 | 116.99 | 85.17 | 18,249,794 | 16,225,158 | -2,024,636 |
| Five years, undiscounted | -9,373,850 |
The skip costs 1,730,667 in the year it is decided and 2,024,636 in year five, when it still takes 11.1 per cent of planned contribution. Over five years it costs 9,373,850 undiscounted, which is 9.37m against a first-year figure of 1.73m. If the business catches up with an 8.16 per cent increase in year two and makes it stick in full, the cost stops at the first year's 1,730,667. Everything between those two figures depends on how much of the catch-up is actually realised, which is the number to measure, as in how to calculate price realisation.
| Elasticity | Year one | Year five | Five years, never caught up, undiscounted |
|---|---|---|---|
| 0.0 (no volume kept) | -2,000,000 | -2,339,717 | -10,832,645 |
| -0.5 | -1,730,667 | -2,024,636 | -9,373,850 |
| -1.0 | -1,456,000 | -1,703,314 | -7,886,166 |
| -1.5 | -1,175,894 | -1,375,629 | -6,369,019 |
Even at an elasticity of -1.5, three times the responsiveness assumed in the case, the skip costs 6,369,019 over five years. To make the year-one skip pay on its own, volume would have to rise 14.71 per cent, which at a constant elasticity means demand at -3.50. A sales team arguing for a quiet year is implicitly claiming that figure.
Put the five-year figure in front of whoever approves the skip: 9,373,850 here, not 1,730,667. If the year is skipped, decide the catch-up at the same meeting and measure its realisation account by account. The three-year price paths at the announced rate and at the rate actually realised are built in the free workbooks for this book.
In arithmetic, yes: an 8.16 per cent increase in year two restores the planned path, and the cost stops at the first year's 1,730,667 in the worked case. In practice a double increase meets more resistance, and whatever is not realised is lost every year after, up to 9,373,850 over five years if none of it sticks.
Enough to replace the contribution lost per unit. With price at 100.00 instead of 104.00 and variable cost at 72.80, unit contribution falls from 31.20 to 27.20, so volume must rise 14.71 per cent in the same year. That implies an elasticity of -3.50, seven times the responsiveness assumed in the case.
Because later increases are percentages of a lower base while costs keep rising. In the worked case the price stays 3.85 per cent below plan for good and the annual cost grows from 1,730,667 in year one to 2,024,636 in year five.
This article is one calculation from Pricing Strategy. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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