Objective Pricing Will a change spur profit? Chart the possibilities
It is rare that a sales force will ask for higher prices or that operations will offer to reduce product cost.Each product and market will have it’s own unique set of market parameters but more often than not aclassic situation will involve sales asking for lower prices to generate more sales and manufacturing or aservice provider requesting higher prices to generate greater profit. When adjusting prices up of downnumerous factors including competitive pricing, profit margins, production capacity and market demandneed to be considered.When prices are increased there can often be a decrease in volume. When prices are lowered you maystimulate more demand and sell more product or services. Most people are painfully aware of this usuallyfairly direct relationship but often don’t take the time to objectively look at the relationship between priceand selling volume to determine the optimum price. Sometimes minor pricing adjustments can createmajor profit impacts.Rather than relying on market prices or gut feel to set your price consider the sensitivities of selling at aprice higher or lower than prevailing market prices. If you sell for higher prices you might anticipatesome loss in volume (unless the higher price itself translates into a perceived increase in product orservice value). The critical question you need to answer is how much volume might be gained or lost andis it worth it?Often managers or business owners react to market price changes based in intuitive reaction or a historyof price following without objectively considering the bottom line impact of their decisions. Thefollowing charts provide simple decision-making tools to help make objective pricing decisions. To usethe charts first determine if you are considering a price increase or a price decrease.If you are evaluating a price decrease find the margin level on the far right column of the top chart that isthe closest to your profit margin now. Next find the percentage price decrease in the row to the left youare considering adjusting your price to yield. The corresponding number in the body of the chartindicates the approximate percentage volume increase you would need to maintain profitability at itscurrent level. For example if you decrease your price from a product with a 50% margin by 30% youwould need to increase sales volume by 150% to make an equal profit contribution. (Assuming overheadcontribution is not an issue)If you are considering a price increase find the margin level in the far right column of the bottom chartthat is closest to your existing margin. Find the percent price increase you are considering in the top rowand match it to your existing margin. For example if you had a product with a 40% margin and you weregoing to raise your price by 30% you could withstand a 43% volume decrease and still make roughly thesame absolute dollar margin.Once you have used the chart to determine the percentage of volume you need to maintain to make a pricedecrease / increase “pay out” or at least be “profit neutral” you can ask yourself the following questions.
How will key accounts react to a price increase / decrease?
Will you be able to attract new accounts if you lower prices?
Who? How Many?
What will your competitor’s reaction be?