There are only a few ways to make more money in business.
The first is to sell more of the things that you have to sell. Instead of selling ten widgets, you sell twenty. Instead of turning over your inventory twice a season you do it three times a season. If your costs stay the same and you’re selling more of your product at the same price, you’ll make more money.
The second is to cut the costs of what you sell. If you can squeeze more profit out of the same product and maintain your sales volume, you’ll make more money. Instead of making $2 per widget, you’ll make $3 per widget and this means more money in your pocket without needing to boost sales.
The third is to raise the price of what you are selling. If your costs stay the same but you raise the price of your product, then you’ll find that extra profit. Instead of making $2 per widget you can make $3 or $4 per widget at the new higher price.
And of course, there is always the option of some combination of two or more of these. The biggest payoff is when you can cut your costs, sell more product, and sell for a higher price. It’s hard to do, but not impossible as the iPhone has proved for Apple over and over again.
Most business will focus on either the first or the second option. After all, once you are selling some product you get an idea of who your customer is, what they are looking for, and where to find other customers like them. Selling more of something will, if everything remains the same, the perfect way to drive profits up.
The second option, too, means extra profits. In mature markets it’s especially interesting as it demands no more market share or increase in sales. Cutting costs means that more profit can be found without any need to increase prices or even expand the market share.
But the third option – raising prices – is one that many businesses baulk at.
But should they?
In this post we’ll explore the idea of raising prices as a means of increasing profits while decreasing cost and energy inputs on the part of the business. It might not be the most popular way to increase profits, but there is a good argument that it could be the most effective.
There Will Be Math
Let’s lay this out with an example.
Imagine you have a widget that costs you $50 but that you can sell for $100. Presently you sell 100 of these per month which means that you make a profit on the widgets of $5000 per month.
Under the ‘sell more’ option you lift your sales by 50% so as to move 150 of the widgets each month. This increase in sales results in an increase in profit of 50%, a total of $7500.
Under the ‘lower costs’ option you find a way to drop the cost of the product by 50% to $25. Now with a $75 profit per widget your 100 widgets earns you the same $7500 profit each month.
Now try the ‘price rise’ option. If the price of the widget goes from $100 to $125 you’ll pocket an extra $25 per widget sold, and your 100 widgets will net you a $7500 profit.
So what is the best option: increase sales by 50%, reduce costs by 50% or up the price by 25%?
The advantage of increasing sales is that your customer base expands and your notoriety grows. The disadvantage is that it is going to cost you money to reach those new customers, perhaps more than the additional revenue that you create.
The advantage of cutting costs is that you can maintain the same price, maintain the same customer base and still make more money. The disadvantage, of course, is that cutting costs is not all that easy. You’ll either be cutting back on staff or looking for a new supplier, and both can be risky bets.
And so there’s the price rise option. The advantage is that it is easy, it doesn’t require any additional investment, and it doesn’t call for any new staff. The disadvantage is also clear, though: you may well lose customers who no longer see the value in your widget at the higher price point. The profit might be there, but it might evaporate if the new price no longer reflects the value of the product in the eyes of the customer.
So: invest in sales, cut costs, or raise prices and risk losing customers?
Pricing for Profit
In his book Pricing for Profit author Peter Wilkins argues that raising prices to where they should be – and communicating the value of that price point to the customer – is the best way to secure greater revenues and build profitability.
Indeed, the driving message of the book is that rising prices is often the best, simplest, most effective, and fastest way to increase profitability for a business
But there’s a catch: the business needs to be able to demonstrate the value in their price.
Here are a few examples of how this might be done:
- Price Add On Elements Separately: The basic service can be priced at X and additional services that add value to the basic service prices separately. For example, consider the example of a basic cheese pizza for $5 and a peperoni and onion pizza for $8. A customer might not grasp the extra value represented by the $3 difference in price, but if you use the cheese pizza as a base and add additional toppings for $1.50 each you’ll get the same price point and the customer will understand the value you are adding with the additional ingredients.
- Make Reductions and Discounts Easy to Spot: Imagine two jackets that are both priced at $100. The customer doesn’t have sufficient information to determine anything about the value of the jacket from the price alone. However, if one of the jackets is reduced in price from $150 and this reduction is clearly communicated then the customer will grasp the additional value in the jacket on sale. Color choice can be crucial here: remember that customers have been trained for years to look for the color red to spot valuable discounts.
- Remember the Number Nine: Value is communicated with the numerals on the pricing ticket, too. A price ticket reading $180.21 is perceived as less of a deal than the same item priced at $179.99. The difference here is not just the 22 cents that the price reveals but more commonly the difference between a sale and a missed opportunity. Consumers perceive value in prices that end with the number nine so shoot for $199 instead of $200, and $999 instead of $1000.
Though it might seem like blasphemy in a competitive market, sometimes raising your prices is the best way to ensure profitability. There’s math to be done and some risk to any pricing strategy, of course, but rejecting a price rise when that price rise, combined with clear communication of added value on the part of your business, can in fact lead to greater profitability in the long term.