Price and Profit

Do you have the right price!

The most significant business variable for delivering significant profits straight to the bottom line is price. Ironically, it is also the variable that many business owners are most reluctant to tinker with. Some business owners can be quite entrepreneurial in their willingness to raise or increase prices, but many are not, and instead carry an overwhelming fear that increasing prices will result in lost customers and/or lower sales. Although this may sometimes be the case, in many circumstances lower sales certainly do not always equate to lower profits. On the contrary, in many cases, lower sales when combined with strategic pricing increases can result in improved profit and cash flow.

So, let’s explore the relationship between price and profit.

Take the example of a business turning over $1m and making a gross profit of $400,000 on their sales. A simple 1% price increase will deliver an extra $10,000 in revenue to the business. This will have no impact on the cost because it is considered by consumers to be a trivial increase. As an example of customer purchase, imagine a client/customer looking at purchasing a $44,000 motor vehicle. Would they quibble if the price rose 1% to $44,400? If they did argue the point, the extra 1% in purchase cost would be very unlikely to deter them from making the sale.

Returning to the example of the business with a turnover of $1m, and the $10,000 increase in profit for selling the same volume of product and maintaining the same purchasing costs, that $10,000 revenue increase represents pure profit which ultimately becomes extra cash in the bank.

Price vs. Volume

Contrasting increased price with an increase in sales volume, the numbers show that to get the same $10,000 gross profit increase through volume, then we need to sell an extra 2.5% of the product. To achieve this we usually have to find new customers, new products to sell to existing customers or increase the number of times a customer buys from us. These challenges require labour and finance – they are significantly harder for the business to achieve than a price increase and may contribute to an increase in overheads or a drain on efficiency.

Here is an illustration of what these numbers look like:

WhatExisting1% price2.5% volume
Sales1,000,0001,010,0001,025,000
Cost of sales(600,000)(600,000)(615,000)
Gross Profit400,000410,000410,000

Many of us have been conditioned to believe that price is the only driver of demand and that changing price will have a detrimental impact on sales. However, we need to put ourselves in the shoes of the customer – for we are all consumers. Think about it! Many other factors influence us when purchasing; there is the quality of the product, brand loyalty, convenience, packaging, complementary products added to the sale, and of course customer experience. In many cases, price is a secondary component for us when buying. This is the same for many of our customers.

Another factor to consider is that potential customers that move because of price are often the ones that cost the business in other ways. They may be the ‘slow players’, the ‘poor referrers’, the customers that need constant attention. These may be consumers you are better off without!

So be brave when reviewing prices. An increase in price can lead to an enormous upside for your business, right to the bottom line!

If you would like to explore the impact of price and volume changes to your business, contact our Advisory Specialists today. We can work with you to understand this relationship in your business and assist in developing plans to accelerate profit through smart pricing strategies. Alternatively, give us a call on (03) 9835 8200.
About the Author
Accru Melbourne , Melbourne
Accru Melbourne, part of the Accru group, is an award winning financial services organisation. Our highly personalised approach and dynamic advice makes us standout in the fast paced, ever-changing business world.
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