May 26, 2010
OPEN Forum Message
Watch MSNBC's Your Business
If you missed this week's show or want to catch up on past episodes, you can find the videos on OPEN Forum.
View videos
Featured Response
“”
Jason Mitchell
The quickest, easiest way to increase your income is to raise your prices. If you're worried about losing customers, do the math. You'll be surprised at how many you can lose and still make more money.
Here's an example. It's a bit dense with numbers, but stick with it. This is an important concept and one that will give you a distinct advantage over those who don't understand it.
Let's say your product or service sells for $200 and your cost is $150. Now you raise your price by 5 percent to $210 per unit and, as a result, you lose 10 percent of your customers.
Before
- Price Per Unit: $200
- Cost Per Unit: $150
- # of Customers: 1,000
- Gross Income: $200,000
- Direct Costs: - $150,000
- Gross Profit: $50,000
Gross Profit Margin: 25%
After
- Price Per Unit: $210
- Cost Per Unit: $150
- # of Customers: 900
- Gross Income: $189,000
- Direct Costs: - $135,000
- Gross Profit $54,000
Gross Profit Margin: 28.5714%
You're actually making $4,000 more profit with 100 less customers!
In fact, in this example, you could lose almost 17 percent of your business and still break even from a 5 percent price increase ($50,000 / 28.6% = $175,000).
- # of Customers: 833
- Gross Income: $175,000
- Direct Costs: - $125,000
- Gross Profit: $50,000
The same math shows why it's a very bad idea to offer discounts, figuring you'll make it up on volume. A 5 percent price decrease in this same situation would require a 25 percent increase in sales just to stay even.
Before
- Price Per Unit: $200
- Cost Per Unit: $150
- # of Customers: 1,000
- Gross Income: $200,000
- Direct Costs: -$150,000
- Gross Profit: $50,000
Gross Profit Margin: 25%
After
- Price Per Unit: $190
- Cost Per Unit: $150,
- # of Customers: 1,250
- Gross Income: $237,500
- Direct Costs: - $187,500
- Gross Profit $50,000
Gross Profit Margin: 21.0526%
That's an extra 250 customers you'll somehow need to woo with your new low prices!
If all that hasn't convinced you to raise your prices and NOT discount, consider that price buyers:
- Are your least loyal customers
- Complain more than premium price buyers
- Expect more than premium buyers
- Will blab about the deal they got to your full price customers
In a prior life, I owned a vintage airplane ride business. It was so popular we could hardly keep up with demand. We often had to turn customers away. Adding planes wasn't really an option as there aren't many of them around any more. Finding pilots whose spouses allowed them out to play with airplanes in their spare time wasn't easy, either.
Putting a spreadsheet to work, we did just the kind of math shown here to evaluate how much business we could afford to lose and still break even. Over the next two years, we eventually tripled our prices before we started to see any fall off in demand. Then we carefully tweaked them until we found that "just right" price that allowed us make the most amount of money with the least amount of work.
Having fewer customers saved us money in other ways. There was less wear and tear on the airplanes, less oil and spark plug changes, less frequent engine overhauls, fewer phone calls/staffing issues, a reduced need for pilots, and generally an easier time making money.
By this point, you're hopefully wondering about your own pricing strategy. Here's a tip. If no one's complaining about your prices or if you have more work than you can handle, you're due for a price increase, or two, or three. Back up those higher prices with a better product/service, better customer service, friendlier staff, or other value-added strategies, and you'll never have to worry about price wars again.
It's always easy to lower your prices if you find you've gone too far. Better yet, keep your prices high to maintain the perceived value of your product or service and offer frequent-buyer coupons, limited-time only-discounts, bulk purchase offers, or other such programs that increase the per customer purchase, and/or lower your unit or fixed costs.
Price wars, discounting, and other price-based competition may make you busier, but as the numbers show, busier is not always better. Unless you "make it up on volume" you'll be out of business and a whole lot more tired than if you'd just left your prices alone.
We'd love to hear your pricing successes (or failures). Has raising your prices worked for you? How about lowering them? Sharing is good. Do tell.
Over the past thirty years, Kate Lister has owned and operated several successful businesses and arranged financing for hundreds of others. She’s co-authored three business books including Undress For Success—The Naked Truth About Making Money at Home (Wiley, 2009) and Finding Money—The Small Business Guide to Financing (2010). Her blogs include Finding Money Advice and Undress4Success.
Check your balance, review recent transactions and pay your bill on the go.
Jason Mitchell 1 year 12 months and 1 days ago
While this is a good article, it is a bit too simplified to paint a truly accurate picture. With this model you are assuming that all costs are marginal costs. As business owners we know that many of the costs that we have are fixed costs and when you add that to the equation your theory does not always hold true. Let's add fixed costs to your equation and see what happens. Your price per unit is $200, your marginal cost is $100 and your fixed cost is $50,000. Now according to your model if you did indeed sell 1,000 units you would have the same profit. But, if you sold anything short of 500 units you would lose money. Now let's look at the discounted model. Your price per unit is $190 and your marginal cost is $100 and you have the same fixed cost of $50,000. Because of the discount you sell 25% more or 1125 units. Your overall income is now $51250 or an extra $1250. This is still less than the example of your price increase, but that is simply a matter of the variables that you plug in. If I was better at math, or if my programmer was writing this, it would be easy to put in variables that show the discounted option has a higher return. I agree that price increases can be good, but I think it is important to look at the whole business picture and not just the aspects that make your argument hold true.