Warren Buffet says that the #1 driver of profits is pricing (he tends to know what he’s talking about when it comes to business and profits!). So, let’s take a look at why discounting your prices is a horrible idea and why INCREASING your prices is, far more often than not, a far better option.
In the example below we have listed your current gross profit along the top of the graph. The amount you discount is along the left. In the middle is the amount your sales have to INCREASE just to get back to where you’d be in Gross Profits if you didn’t discount. So in this example, if you have 40% Gross Profit margins and you discount by 20%, you must increase your total sales by 100% just to make the same amount of money in gross profits as you would if you didn’t discount. For example, if you sell a widget for $1,000 and at 40% gross profit, you make $400/widget. If you discount your price to $800 (20%), your Gross Profit will drop to $200 each. So now you’ll have to sell two of those widgets to make what you were making before in Gross Profit ($200 X 2 = $400). Do you really think it’s likely that with a discount (which isn’t really even very motivating for many people anymore) that you will sell twice as much? It’s highly unlikely. Also, for those of you who are making around 10% NET Profit, if you discount by 10%, guess what happens? You’re working for free! Sometimes I hear “Yes, but I’ll make up for it in volume”. Well I ask you, if you add a whole bunch of zeros together, what does that get you? Zero! You’re just working a lot harder for free!
All of this means you’re only cutting your profits. And for what? More work? Please only do this if you have too much money, too little work, and too little stress. Instead, consider INCREASING your prices.
Let’s now look at what happens when you INCREASE your prices. In the graph below, let’s say you have 40% Gross Profit margins and you increase your prices by 10%. You can stand to lose 20% of your sales/customers and still make the same amount of Gross Profit. It rarely ever happens that small businesses lose anywhere near that amount of sales from price increases- but if you’re worried about trying it, you can stand to lose fully 1/5 of every customer or sale and be no worse off- isn’t that worth a try?! Now, for fun, let’s look at what you could lose if you increased your prices by 40%. You could lose HALF of your total sales and still be in the same shape Gross Profit wise. Isn’t that something! 50%!
This is serious stuff. I had a client years ago that I tried and tried to convince to increase his prices, but he refused. He was so caught up in thinking that revenue/sales numbers were so important that he refused to sacrifice any sales to increase profits. His business actually does a whopping $5 million in annual sales. But he lives a crazy hectic life because he’s constantly struggling with cash flow. Why? Because his margins are too thin. If he would increase all his prices overnight by 10%, he would most likely go from about $5 million in sales to around $4.5 million but his Gross Profit would go from about $1,750,000 to $2,250,000. Most of that additional Gross Profit, by the way, would go straight to the bottom line. Think about it- what costs are associated with price increases? There’s not an increase in volume so expenses wouldn’t rise as a result- they will normally stay about the same. So that’s an additional $500,000 in NET PROFIT that he’s leaving out there because he’s afraid to raise his prices. Instead he chooses to live a life in chaos chasing the almighty Revenue Dollar, rather than caring more about Gross Profit Margins (through pricing strategy).
There are obviously exceptions to the idea of it being a good idea to raise prices. One is if you’re already at or toward the top of the pricing regarding your competition. It may not (still though not always) be a good idea to increase again. Another would be if you’re in an industry whose product/services has become more or less commodities. One of the businesses I am a co-owner of is a golf club. We’ve tried to raise our rates, but it’s such a rate-competitive industry that we end up losing when we do try raising rates. So we have had to figure out other ways to increase profits. If you’re in a very price-competitive business, you need to be careful about raising rates. But I always tell my clients that if you can’t charge what you need to in order to make enough money to meet the standard or goal you’ve set for yourself, you’re faced with two options: 1) Consider it a sinking ship and, as Warren Buffett says, you’d probably spend your time more wisely by seeking an alternative ship than you would repairing the holes. Or, 2) Figure out a way to differentiate yourself enough that you can justify charging higher prices.
Be good to yourself. Increase your prices if you can and consider discounting to be a poison. You may have to drink that poison at times, but take it small doses and as infrequently as possible.
All the best and remember: “Things may come to those who wait, but only the things left by those who hustle”. -recent fortune cookie of Jon’s
Call me if I can be of any help to you in growing your business or anyone you know that owns a business: 651-275-8999