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VAT increase sends pricing strategies into disarray

14th Dec 2010
Deputy Editor Sift Media
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AIA

Retailers are using the VAT rate increase as an excuse to hike up their prices over and above the 2.5% added tax they need to pay.

Almost two in five businesses plan to increase prices immediately on 4 January, while nearly 30% plan to absorb the VAT rise within in the business, according to Baker Tilly’s Outlook 2011 survey. A further 10% plan to gradually increase prices over a period of time leading up to January and 4% have already increased their prices.

A similar study by KPMG found that around 60% of UK retailers and consumer goods manufacturers intend to raise prices over and above the 2.5% VAT rate increase.

“The economic downturn placed pressure on UK businesses to blanket discount, and the intention to raise prices is an understandable reaction, but the timing must be right. In today’s price-sensitive market, any increases may well have a damaging effect on sales volumes. Firms need to understand the overall impact on profitability,” said Martin Scott, partner at KPMG Performance & Technology.

The KPMG research shows that a majority of firms were forced to discount prices across the board during the recession. It now appears that many are looking to use the VAT increase to mask price increases.

“However, downturn discounting has re-set the price baseline for consumers, who are now unwilling to pay more for goods and services. Companies need to be wary of first mover disadvantage,” added Scott.

In the bid to keep prices low, some businesses are not passing on the additional cost of the VAT increase and are instead choosing to absorb the cost within their business. This is a dangerous strategy for those struggling with working capital, warned Baker Tilly this week.

 “In areas where a business can’t recover VAT, it will effectively mean margins are reduced if it is unable to pass the increase on to customers. If companies attempt to absorb the VAT increase where they are only marginally profitable, it will only add to their financial pressures,” said Tony Wright, restructuring and recovery partner at Baker Tilly.

“Time To Pay arrangements made in respect of VAT charged post 4 January 2011 will, in real terms, be at a 14% higher level than those agreements made in respect of pre-2011 debts. This will pose further working capital pressures on those businesses whose viability is already questionable,” he added.

Careful analysis of pricing is required to keep business on an even keel after the VAT increase, said Scott.

“Businesses need a robust pricing strategy, built on a thorough understanding of their customers, and need to be aware that their customer base may have changed during the recession.

“Given that the majority of companies recognise that it will be a challenge to increase prices from discount levels set during recession, it is critical that firms understand the impact of price rises on their markets, before making sudden changes to pricing structures to coincide with the VAT increase”.

More advice on the VAT rate change:

VAT switch: tax point rules clarified

 

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