How do you price your product or service? Do you use cost plus a margin, charge extra to position yourself in a premium niche, match the industry’s going rate, or discount to increase volume? Is pricing your key competitive advantage or do you compete on other factors such as quality, service, speed, guarantees, convenience, or exclusivity?
My conversation with a discounter
I recently had a pricing conversation with a small business in an industry with relatively few competitors, including some well-known national brands.
This business was charging only 60-70% of the competition’s average price, although discounting was not marketed as a lead generator to increase volume. Additionally, the service provided is high value and non-recurring with significant impact on customers… you don’t shop around for the cheapest brain surgeon, you shop around for the best brain surgeon to get the job done right!
If this business increased their price to the industry average they could immediately increase revenue by a massive 42% with no extra work nor additional direct costs.
This business historically reports a steady gross margin of 39%. Increasing prices by 42% would immediately increase the gross margin to 57%. A massive improvement and an accountant’s dream!
But what if we lose customers?
Most businesses worry they will lose customers if they increase prices. That may be true, but if you work the numbers you will know exactly how many you can lose and still be no worse off in dollar terms.
In this example the business could lose 52% of its customers before its gross profit would reduce to a level lower than prior to the price increase. With careful implementation it is unlikely this business would lose any customers as their new price is the industry average, and they offer a quality service.
Discounting to increase market share and revenue
Some businesses discount to boost market share and volume. But discounting can negatively impact bottom line profitability.
For example, if in a few years the small business in our example decided to discount their new industry average price by just 15% then their gross margin would reduce from 57% to 49%. They would have to increase sales volume by 36% just to make the same gross profit as prior to discounting their industry average price. The key question then becomes “will a 15% discount lead to a 36% increase in sales volume?”
Know your numbers before you price
Increasing or reducing your prices, on all or just some of your products or services, could be a competitive strategic move. But before doing so consider the potential impact on profitability.
Q2 Ltd’s Pricing Change Impact Resource helps determine the impact of a change in pricing on the number of customers needed to be no better or worse off. If you would like a free copy of this resource contact info@Q2.net.nz.
“Profit is not something to add on at the end, it is something to plan for in the beginning”.