By Brad Sugars – ActionCoach.com
In more than 25 years of making pricing decisions and of observing others making pricing decisions, I have come to the conclusion that there is no single business decision that can be made more quickly, but which deserves more cautious consideration than the decision of what to charge for one’s goods and services.
As a business coach, it never ceases to amaze me how business owners and managers make such an important decision with so little rationale for their decisions and more shockingly – virtually no analysis of the impact of their decision.
What a business charges for its goods and services directly impacts how much revenue it has and more dramatically how much profit it has. If you set your prices too low, you’ll go broke! Set your prices too high and you’ll also go broke! In the case of “too low” prices, you end up with lots of sales volume (at very low margin) but not enough gross profit to cover your fixed expenses. In the case of “too high” prices, even though you make a lot for each sale, you won’t have enough sales or revenue to generate a profit.
Consider a business that has a Gross Profit Margin of 40%. A 10% decrease (or increase) in prices will decrease (or increase) Gross Profits by 25% (assuming no change in volume). Depending on the level of fixed expenses, net profit will change more dramatically.
But wait a minute; if you decrease prices won’t you make it up in volume? Maybe. Using the same a assumptions – 40 % Gross Margin and a 10% price decrease, since you are selling the units at a lower price and a 25% lower margin, you’d have to sell 35% more volume just to break even on your price discount!
So the next time you are thinking of changing your prices, do the math. Figure how much more (or less) you’ll need to sell compared to where you are today. If it seems reasonable, go ahead. If it doesn’t, move on to another profit generating strategy.