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

 

 

12 Comments

  1. Ken Crabb

    Jon, Very interesting. Too bad I cannot raise prices (payments are set by insurance companies) but I would if I could. Also it points to the need to control payers. I did not realize how much before. Thanks.
    Ken

    • admin

      Hi Ken,
      I think this can also influence future decisions on whether or not to accept certain forms of govt aid- or at least to what extent… Thanks for the feedback. -Jon O’

  2. This is a very compelling article. Since we DO set our own prices around here, applying this idea could make a big difference to our bottom line. I am going to share this with my business partner, our CFO.

    • admin

      Sure Bob- you’re welcome. I’m glad to hear you’re going to take action. Although if too many of us do the Fed Reserve is going to have to revisit their projections for inflation! Good luck!
      -Jon O’

  3. Dick Quandt

    Very good message Jon. Useful to customers in the contracting business even though most believe they cannot raise prices due to competition. I’ve share with our clients.

    • admin

      Dick,
      That’s a very common belief in the contractor world. It’s a big reason why so many of them struggle with cash flow… Thanks for the comment.
      -Jon O’

  4. Jon this is a great message and more businesses should be paying attention to these items (which I know many of them don’t). I will share this with some of my clients that might be able to benefit.

  5. admin

    Thanks guys. I’m glad you appreciate it. This is such an important issue for so many businesses and often over-looked. So share what you’ve learned with other owners you know!

  6. Matt Johnson

    Jon, This is very intersting. Unfortunately, my biggest hurdle is PBM reimbursement, which is a set price. We will take a look at this strategy on the retail side though. Thanks for sending it along.

    • admin

      Hi Matt,
      Yes I know those reimbursements are a thorn in your side. On the retail side this definitely is more pertinent. Obviously using prudence as you don’t want to price yourself too far above the competition. The biggest thing is just understanding that you can’t compete, and don’t want to try to compete, with the bigger retailers on price. You have to justify the difference though and that’s where super friendly/above and beyond service that we talked about comes in.

  7. Well written article Jon. There is a lot of truth in this article. As noted above there are times when you cannot setup your own prices, However for those who can – this really is a must read. Too many times customers will tend to think offering discounts will improve turnover and by more turnover they will be sitting on larger profits. Unfortunately most find themselves working more and ending the same cash position – exactly as you described above.

    This really shows details it out for someone to look at. I will try to post on my website, as long as you are ok with it and provided I can figure out how to get it on my website.

    • admin

      Hi Keith,
      Absolutely. Post away! Glad to hear the article is helpful for you and your clients. Merry Christmas!
      -JO’

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