Any first-year accounting student can tell you that
Profit = Volume x Price – Expenses
It follows that if you want to grow profit then you need to do at least one of 3 things:
- Grow volumes
- Increase prices
- Reduce Expenses
Now of course it isn’t quite that simple. If you increase prices too much then you won’t be competitive (ie your volumes will fall). And if you reduce expenses then your product or service will suffer which once again will impact your volumes.
There is an optimal level of pricing (and expenses) in every business. Sadly, most business managers don’t have the tools to work out the optimal level. Even more sadly, they don’t get the help they so badly need.
This is especially unfortunate because optimising prices is the easiest way to have a material impact on profit. According to McKinsey, one of the world’s leading management consulting firms, optimising prices has 7 times more impact than growing sales.
Let’s understand why this is. Suppose your business has revenue of $1,000, expenses of $900 and profit of $100. If you are able to increase volume by 10% (revenue will increase from 1,000 to 1,100) then your expenses might increase by say 8% (from 900 to 972). Overall your profit increases from 100 to 128, a 28% increase. However if you increase prices by 10% it goes straight to the bottom line because your expenses don’t change. Your profit will increase from 100 to 200, a 100% increase. Even if your volume reduces slightly, your expenses will reduce too.
There will be times when you can increase prices more than others, and some products where you can increase prices more than others, without impacting volumes. That’s where it is important to understand supply, demand, and customer behaviour. And it’s where we can help.
So what are you doing to optimise pricing in your business?