If you put your prices up you would probably lose some business – right?
But do you know how much sales volume you could afford to lose – yet still be as profitable as you were before you hiked your prices?
Every business is different and you need to understand how the “Price : Volume Dynamic” affects your business.
The best place to start is probably to describe the 2 constituents of this dynamic (and something else called Gross Profit % or “GP%”) and then explore the relationship between them:
Price – the amount you charge for your product of service
Volume – the number of units/hours/square feet let (whatever your “unit of sale” might be). Put another way, a measure of how busy you are
Gross Profit % – an arithmetical calculation showing your Gross Profit (Sales less Cost of Sales) as a percentage of your Sales.
If you ask any business person what would happen if they were to increase their prices across the board by, say, 5% you would be on the sharp end of a litany of “what, hit the self-destruct button?/our customers would leave in droves/we simply cannot do that” etc.
A natural and understandable reaction? Maybe.
But hang on a minute – let’s look at this in a bit more detail:
Will our customers leave in droves?
Sure, some will probably leave, highly unlikely that all will. And it is typically your problem customers (you know who we mean – the ones who soak up your time, constantly push you and your team for discounts and regularly complain) that will be the first to go.
Hardly a disaster in itself. But do you have any idea how much “volume” you could afford to lose yet still generate the same profit as you were doing before you hiked your prices?? This is where the dynamic comes in …
How the Price : Volume Dynamic works
Logic surely dictates that if you raise prices (and don’t change anything else) that you will make more profit; in fact, every penny more you charge goes straight to your bottom line – happy days!
So how much volume could you afford to lose? Surely it would be fair to assume that if you put your prices up by 5% then you could lose 5% of the volume and be back where you were before – WRONG (usually)! Every business is different – but the rule of thumb if you are a manufacturing business making a Gross Profit of, say, 30% is that you can “afford” to lose 14% of your volume.
And it gets better! If you were working at a 15% gross profit % and increased your prices by 5% you could “afford” to lose a whopping 25% of your volume – that’s a quarter of what you are doing now!! Or, in other words, you could be working at three quarters your existing level and still show the same profit – goodbye, busy fool!
There is a sinister flip side to this coin: in these competitive times your sales team might quite possibly tell you “we must reduce our prices to get business”. Before you do anything – THINK! If you are making a 15% gross profit and you followed the advice of your sales team and reduced prices by, say, 5% – then you would have to sell 50% – YES, that is 50% – more stuff (units/hours etc.) just to stand still. Have we got your attention now??
If this is all meaningless gobbledegook or you see this as nothing more than a theoretical exercise – please think again.
You simply must understand this dynamic and how it affects your business – especially if you are contemplating reducing prices.
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