Pricing
Typically, when prices go up sales go down, and when prices go down sales go up. The challenge, however, is that this is not a direct relationship. A 10 percent price reduction will not necessarily guarantee a corresponding increase in sales and a 10 percent price increase will not necessarily guarantee a corresponding decrease in sales. It could be more, it could be less, or it could be exactly the same. Your goal is to establish a price that will maximize your profits, but as you can see, this is as much an art as it is a science.
Suppose you own a company with the following abbreviated Income Statement.
| Sales | $100,000 | 100% |
| Variable Expenses | $40,000 | 40% |
| Fixed Expenses | $40,000 | 40% |
| Profit | $20,000 | 20% |
Most small businesses could raise their prices by up to 10 percent with a minimal decrease in sales volume. This may or may not be the case with your business, but a small decrease in sales volume has less of an impact than many business owners realize. Consider the following example.
Suppose that you raised your prices by 10 percent and experienced an equivalent decrease in sales volume as a result. Your total revenues would stay the same, but your profit would increase by four percent to $24,000. Why? Because, while your “fixed expenses” might not change, your “variable expenses” would decrease by 10 percent in response to your lower sales volume.
The numbers would now look like this.
| Products | Product 1 | Product 3 | Product 6 | Total |
|---|---|---|---|---|
| Price/Unit | $50 | $20 | $40 | N/A |
| # Sales/Month | 3,000 | 5,000 | 2,000 | 13,000 |
| Net Sales | $150,000 | $100,000 | $80,000 | $330,000 |
| Profit/Unit | $5.00 | $1.40 | $6.00 | N/A |
| Total Profit | $15,000 | $7,000 | $12,000 | $34,000 |
| % Profit | 10% | 7% | 15% | 10.3% |
| Products | Total | |||
|---|---|---|---|---|
| Price/Unit | ||||
| # Sales/Month | ||||
| Net Sales | ||||
| Profit/Unit | ||||
| Total Profit | ||||
| % Profit |
Product Relationship Grid
Most businesses sell more than one product or service. If this is true for you, then one of your sales goals is likely to increase your revenues per customer by up-selling (i.e. selling a better, more expensive model), cross-selling (i.e. selling additional items that complement the purchase), or multiple selling (i.e. selling more of the same thing).
Your pricing structure for up-selling will likely be relatively simple. People will often purchase a more expensive model if the additional features are compelling and the price increase is modest.
With multiple selling, your pricing structure will be simple as well. You can easily offer some type of discount or bonus for product orders over a certain size.
Pricing structures for cross-selling, however, can be a little more complicated. If your company sells a variety of products or services, then your customers may see them as groups rather than as individual items. In this case, the question becomes, where should you make your profit? If you own a chain of family restaurants, for example, it may make sense to offer a lower margin breakfast special, but to charge a little more for coffee and juice. It is important to generate your overall margin, but there are many different ways to get there.
Use a Product Relationship Grid to identify your product and service groupings. Begin by listing your various products and services along the top of the grid and do the same down the left hand side. Next, run down the list and place a checkmark at every product that may be purchased in conjunction with another. Remember to file and share it when you are done.
| Product 1 | Product 2 | Product 3 | Product 4 | Product 5 | Product 6 | |
| Product 1 | x | x | x | |||
| Product 2 | x | x | x | x | ||
| Product 3 | x | x | ||||
| Product 4 | x | x | ||||
| Product 5 | x | x | ||||
| Product 6 | x | x | x |
Pricing Charts
Pricing Charts pull important, price-related information together, helping you see the financial relationships of your various products and services more clearly. If you are aware of the profits you regularly earn from each of your products or services and if you know the sales volume for each of your products, you can then experiment by adjusting these figures to estimate the impact of various pricing structures on your business as a whole. Remember that some of your products may support each other while others may stand alone. As a result, understanding your customers' needs is really the first step.
If appropriate, use a separate chart for each of the product groups you identified above on your Product Relationship Grid. To anticipate the effect different prices will have on your sales volume, look to industry standards, your competitors, and your own experience for input.
Begin with your existing price structure, and then experiment with different pricing structures using the charts below. They won't give you definitive answers to your pricing questions, it's too intuitive a process, but they will help you make more informed decisions.
| Sales | $100,000 | 100% |
| Variable Expenses | $40,000 | 40% |
| Fixed Expenses | $40,000 | 40% |
| Profit | $20,000 | 20% |
Most small businesses could raise their prices by up to 10 percent with a minimal decrease in sales volume. This may or may not be the case with your business, but a small decrease in sales volume has less of an impact than many business owners realize. Consider the following example.
Suppose that you raised your prices by 10 percent and experienced an equivalent decrease in sales volume as a result. Your total revenues would stay the same, but your profit would increase by four percent to $24,000. Why? Because, while your “fixed expenses” might not change, your “variable expenses” would decrease by 10 percent in response to your lower sales volume.
The numbers would now look like this.
| Sales | $100,000 | 100% |
| Variable Expenses | $36,000 | 36% |
| Fixed Expenses | $40,000 | 40% |
| Profit | $24,000 | 24% |
Your Pricing System
Create your Pricing System.