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 a classic situation will involve sales asking for lower prices to generate more sales and manufacturing or a service provider requesting higher prices to generate greater profit. When adjusting prices up of down numerous factors including competitive pricing, profit margins, production capacity and market demand need to be considered. When prices are increased there can often be a decrease in volume. When prices are lowered you may stimulate more demand and sell more product or services. Most people are painfully aware of this usually fairly direct relationship but often don’t take the time to objectively look at the relationship between price and selling volume to determine the optimum price. Sometimes minor pricing adjustments can create major profit impacts. Rather than relying on market prices or gut feel to set your price consider the sensitivities of selling at a price higher or lower than prevailing market prices. If you sell for higher prices you might anticipate some loss in volume (unless the higher price itself translates into a perceived increase in product or service value). The critical question you need to answer is how much volume might be gained or lost and is it worth it? Often managers or business owners react to market price changes based in intuitive reaction or a history of price following without objectively considering the bottom line impact of their decisions. The following charts provide simple decision-making tools to help make objective pricing decisions. To use the 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 is the closest to your profit margin now. Next find the percentage price decrease in the row to the left you are considering adjusting your price to yield. The corresponding number in the body of the chart indicates the approximate percentage volume increase you would need to maintain profitability at its current level. For example if you decrease your price from a product with a 50% margin by 30% you would need to increase sales volume by 150% to make an equal profit contribution. (Assuming overhead contribution is not an issue) If you are considering a price increase find the margin level in the far right column of the bottom chart that is closest to your existing margin. Find the percent price increase you are considering in the top row and match it to your existing margin. For example if you had a product with a 40% margin and you were going to raise your price by 30% you could withstand a 43% volume decrease and still make roughly the same absolute dollar margin. Once you have used the chart to determine the percentage of volume you need to maintain to make a price decrease / increase “pay out” or at least be “profit neutral” you can ask yourself the following questions. o o o o 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?

o

Do you have the capacity to meet increased demand or can the capacity freed up by lower demand be more profitably redeployed somewhere else?

All of these questions need to be addressed keeping in mind your overall business objectives and should be influenced by your desire to grow, hold, or harvest your market position.

Pricing Optimization Matrix*
Selling Price Decrease
Additional volume required to break even 60% xxx xxx xxx xxx xxx 50% xxx xxx xxx xxx 500% 40% xxx xxx xxx 400% 200% 30% xxx xxx 300% 150% 100% 20% xxx 200% 100% 67% 50% Product Margin 10% 100% 50% 33% 25% 20% 20% 30% 40% 50% 60%

Selling Price Increase
Volume decrease possible to maintain profit contribution (break even) 10% 33% 25% 20% 17% 14% 20% 50% 40% 33% 29% 25% 30% 60% 50% 43% 38% 33% 40% 67% 57% 50% 44% 40% 50% 71% 63% 56% 50% 45% 60% 75% 67% 60% 55% 50%

Product Margin 20% 30% 40% 50% 60%

Projections are rounded estimates – Precise calculations should be done for exact price determination Assumes that product cost do not change with volume. (This model does not address changes in fixed or variable cost due to dramatic changes in either a negative or positive manner. Consult your accountant for additional guidance regarding these issues.) Source- Topline Development LLC

About the Author – Scott Francis is the author of “Marketing Is About Making Money.” and President of Topline Development, a strategic marketing consulting group that helps companies maximize profits through positioning, pricing, and new product development and “go to market strategies” . Learn more about Topline Development at www.ToplineDevelopment.com or contact Scott directly at Scott@ToplineDevelopment.com

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