The relationship between price and profit.
Price, more than any other variable in business, can deliver significant profits straight to the bottom line. Ironically, it is also the variable that many business owners are most reluctant to tinker with. There is an overwhelming fear that increasing price will result in lost customers and lower sales. That may well be the case but lower sales does not always lead to lower profits. In fact, in many cases, lower sales can result in improved profit and cash flow when combined with strategic pricing increases.
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 those sales. A simple 1% price increase will deliver an extra $10,000 in revenue to the business with no impact on cost. $10,000 for selling the same volume of product and maintaining the same purchasing costs. The $10,000 revenue increase represents pure profit which ultimately becomes extra cash in the bank.
If we contrast this with an increase in sales volume we need to sell an extra 2.5%, or $25,000 of the product to deliver that extra $10,000 in gross margin and ultimate profit. 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. All significantly harder for the business to achieve than a price increase.
Many of us have been conditioned to the belief that price is the only driver of demand and that changing price will have a detrimental impact on sales but you need to put yourself in the shoes of the customer – we are all consumers. Think about the many other factors that influence you when purchasing; quality, brand loyalty, convenience, packaging, complementary products and the customer experience. In many cases, price is a secondary component for us when buying and it is the same for many of your customers.
One last consideration, is the customers that move because of price are often the ones that cost the business in other ways. The slow payers. The poor referrers. The customer that needs constant attention. As a business we may be better off without these types of customers.
So be brave when reviewing prices. It can deliver enormous upside to 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 though smart pricing strategies. Alternatively, you can complete your contact details below or give us a call on (03) 9835 8200.