Pricing’s Impact on Profitability
Pricing has the greatest impact on profitability.
See for yourself with our interactive calculator.
- by
- Ryan Maley
Getting your price right is the best way to increase profits and a key part of management. Many companies try to grow profitability through increasing their sales volume or cutting costs. Companies should definitely do these things, but this is simply a less effective than increasing prices. Let’s look at some numbers.
The Numbers
First, we’ll use the classic cost-volume-profit formula:
For example:
Sales Price | $ 10 |
Volume (or Quantity Sold) | 100,000 |
Fixed costs (total) | $ 500,000 |
Variable Costs (per Unit) | $ 4.50 |
Profit | $ 50,000 |
Let’s imagine a very small change. A 0.5% improvement across each of the variables independently:
We can see the greater impact of a very small price increase in this case almost doubling the percentage increase in profits compared to any other changes. Companies with different mixes of variable costs and fixed costs will see different results but a higher price will always have the maximum impact on your profitability.
This is not to say you shouldn’t improve in every category. You should, but if you are a pricing manager, marketing manager, or a salesperson, all those other variables are out of your control. How will you have the greatest impact on profitability? Raise your prices.
Try It for Yourself
Curious about how this would look in your business? We’ve built a simple interactive version of this for you to play with. Just enter your variables and see the effect right now. If you are concerned that you have a lot of products, look at a single product or use averages for your prices and total volume of all your products. You will still get a good idea of the rough order of magnitude effect of a price increase.
Note: None of this information is stored and we do not make any effort to track you on this web page.
Why doesn’t everyone just raise their prices?
This is a very simple model and an increase in prices can have other effects such as decreasing quantity sold based on customer’s willingness to pay and other factors. These issues can be addressed with good analytics, customer segmentation, and other techniques. (We’ll talk about these topics in other posts.)
One other very important objection comes not from your customers, but from inside your company. Your colleagues may say “raising prices is hard”.
Most salespeople are dealing with increased competition. Many of their customers and prospects are asking for low prices even before prices are discussed. And some of your competitors may be more than willing to accommodate. Lowering a price is usually the easy way to compete and many organizations incentivize salespeople on metrics like increased volume, net new customers, or reduced churn even when this doesn’t match the company’s goal of increasing profitability.
Many companies treat every customer like every other customer. Your products or services are more important to some customers than others and that is often reflected in the price those customers are paying today. It is easy to remember the anecdotes of salespeople and get complaints about prices, but if you have customers that are paying a higher price, you have proof that it is possible to charge more.
What to do?
In our next post, we’ll discuss another way to think at how to raise prices, price levers. Levers are the mix of discounts, rebates, and other price changes and free services that actually reduce your price. We’ll do some analysis to show how price levers reduce your profits.
Ryan Maley is a management consultant with Stratence Partners, a specialized consulting firm that helps companies get the most from pricing by helping optimize strategies, implement pricing excellence, and increase commercial effectiveness.
© 2021 by Ryan Maley. All rights reserved.