When there is less business about, sales volumes are lower, and there is a general tendency to decrease prices to win business and revenue, business owners often focus on cost cutting.
However, beware! It is pricing decisions that usually have the largest impact on profitability.
Let me explain this rather daunting picture in more simple terms.
Leaving aside the fact that you want to increase profits, on the basis you want to maintain current profitability, the graph shows the change in the volume of sales needed to achieve this as we vary the price.
The coloured lines are the existing gross profit margin of the business. The blue line shows a 10% margin, say where sales are £100 then the direct costs of sale would be £90 leaving a profit of £10 and a margin of 10/100 = 10%. The red line 20% margin and so on.
Now go and get your last set of accounts. If your accountants have not put it on the profit and loss account for you, work out what your margin was. Make sure you include all the costs that vary directly with sales – not all accountants do this.
You need to decide what to change your price by; this figure is represented by the horizontal axis on the chart. Look at that in the context of your business and consider what you would need to do to sales volumes to maintain existing levels of profit.
What’s most interesting to me is the steepness of the curves. A drop in price and the volume of revenue increase required is significantly steeper than the volumes you can lose when increasing prices.
At a 10% margin, if you increase your prices by 5% you can lose a third of your turnover and still make the same profit. The majority of businesses we see have margins between 20% and 40% - so taking 30% as the average a 10% increase in price means you can lose 25% of your revenue and still maintain profitability.
In a 10% margin business you can lose 83% of your sales if you raised prices 50%. You may feel you’d actually lose 100%, and of course everything in life is a balance, but this should start to highlight the potential that could be there.
If you think or are told you’re more expensive than ‘Smith & Sons’ down the road - why is that? Can you justify the added value of your product or service over competitors? If not, then why not? You must be able to think of something that tangibly differentiates your offering from your
competitors in the eyes of your customers around quality, price or speed of delivery.
Nearly everyone we work with initially says that they can’t increase their prices but the ones who have justified increases are making more money than they did before. There has also been far less price resistance from customers than you might expect. I believe this is because those businesses understand their value proposition and now know more about why people buy from them (and why they don’t).
A key factor in the purchasing process is the fear of making a buying mistake; whether that be the availability of the ‘same thing’, cheaper elsewhere, buying the wrong product, or the potential for criticism from family, friends or even the boss. That’s why trust is so important, why millions are spent promoting brands worldwide and why you need to focus on reducing the risks your customers are taking by buying from you.
In conclusion, let’s be clear. It may not be the right time to increase all your prices by 50%! However, I am saying arm yourself with all the information you need to make good decisions. Reducing prices is hardly ever the best way to prosper in tough times – as a good number of people we know will tell you.