How different pricing strategies can impact your business
About the Author:
Mike Atkinson
Director and FCA at Bellingham Wallace
Mike has a wealth of practical experience, commercial know-how and passion for challenge. His clients appreciate his genuine interest in their businesses and ability to quickly cut complex issues down to size.
Choosing to discount or raise prices is going to create a ripple effect that will impact other areas of your business. But how and to what extent?
Impact of Discount Pricing Strategies
When competition gets tough it's tempting to resort to discounting, but it can cause huge cash flow problems for a business and often pricing problems might be a symptom of other weaknesses.
Inevitably discounting is a short term solution with a long term impact which has the potential to devastate profits. However, it is important to consider discounting as a tool to manage your stock and in turn your working capital.
The table below outlines how much more you'll need to increase your sales by in order to make the same amount of money, based on various Gross Profit Margins and discounts. Food for thought! Hopefully your accountant has used a similar model to explain the effects
Given a price reduction, to achieve the same profit your sales volume must increase by:
For example, at a 40% margin, a 10% decrease in price would require sales volume to increase by 33% to maintain the same level of profit. Ouch!
Many businesses will have a business development manager (BDM) or sales team. Typically their performance is linked to how much they sell. Unfortunately some will resort to discounting as a tool to secure a sale, without realising the larger impact. Educating your sales team on the true impact of discounting is therefore paramount. Alternatively you may want to think about restructuring performance incentives around their gross profit return - this is something we have done for our clients.
IMPACT OF PREMIUM PRICING STRATEGIES
Raising your prices will have the opposite effect. Based on various Gross Profit Margins, the table below shows what happens to sales volumes when a premium pricing strategy is introduced. Given a price increase, your sales could decline by the amount shown below before gross profit is reduced:
For example, at a 40% margin, a 10% increase in price could sustain a 20% reduction in sales volume.
If you are considering your pricing strategy, start by determining if your business and the individual product lines it offers compete on:
Price This would direct a "lower price, lower margin, higher volume" approach, or
Differentiation i.e. be the product leader. This would allow you to support a "higher price, higher margin, lower volume" approach, at least until your competitors start stocking the same product, or
Customer Experience i.e. service, customisation, larger variation in product assortment. This would help sustain a "higher price, higher margin, lower volume" approach. It's okay to be priced higher than your competitors, as long as you meet your customers' expectations of quality and value.
The general rule of thumb is that you need to match the market in two and beat the market in one. There are obviously many other factors relating to personal circumstance that need to be taken to account.
If you are faced with shrinking margins, the answer is not necessarily to discount price under the assumption that his will trigger the necessary increase in sales to make up the difference. The basis on which you compete will drive your decision in the short term. The longer term objective, however, should be to provide customers with a compelling reason to focus on something other than price - namely value.
Director, FCA
Bellingham Wallace
Ph 09 367 1634
www.bellinghamwallace.co.nz
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