We always encourage you to undertake competitor and profitability analysis on each of your products or services. The price profit model is an invaluable tool in this analysis and enables you to become more courageous in your pricing decisions.
Your gross margin is a vital aspect in your profit model. As this is the difference between your selling price and the cost of buying in or producing your products or services, the only way to increase your gross margin is by increasing your selling price or by reducing your purchase price or production costs.
One of the largest barriers preventing businesses achieving acceptable profit levels is their reluctance to charge the right price for their goods and services. Yet studies show that price is the influencing factor in the purchasing decision in only 15 percent of cases.
Trying to hold or win market share on the basis of price discounting is the lazy man’s competitive strategy. It is applicable in only one situation and that is where you have a definite cost advantage (either fixed or variable) over your competitors, and your product or service is one where customers are very price sensitive.
The price profit model below shows the increase in sales that is required to compensate for a discounting policy. If your gross margin is 35 percent and you reduce price by 8 percent, you need sales volume to increase by 30 percent to maintain your initial profit! Rarely has such a strategy worked in the past, and it’s unlikely to work in the future.
On the other hand, the next table shows the amount by which your sales would have to decline following a price increase before your gross profit is reduced below its initial level. At a 25 percent margin and an 8 percent increase in price, you could sustain a 24 percent reduction in sales volume before your profit is reduced to the initial level – you would have to lose 1 out of every 4 customers!
If you would like to find out more about the Winning Company Programme, please contact us.