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  • Pricing, Profit and Sales
    Getting your prices right is critical if you want to survive the recovery Read more
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  • Instantly calculate the effect on your profit of a price change
    Businesses are coming under more and more pressure to reduce prices. Many will yield to that pressure in the hope that a price reduction will increase or at least sustain sales. The loss of profits that result can destroy the business. Use this calculator to understand the implications of changing p Read more

Pricing Profit and Sales

In the current hard trading conditions companies can be tempted (and are often advised) to reduce prices to increase sales. This seems like a sensible idea at first glance but you need to consider the effect of this on your profits and the ability of your business to survive in the long term.

Many business pundits rightly emphasise the importance of cash flow in troubled times and if cash flow dries up your business will almost certainly fail; but cash flow without profit is only delaying the inevitable failure that will occur if allowed to continue for too long. Growing your sales can be the wrong thing to do in recessionary times. It will result in a need for additional working capital that your bank may be reluctant to provide. More sales can also mean an increase in debtors and so the problem gets worse, not better.

If you currently sell a product with a 30% gross profit margin and to sell more you reduce the price by 10% you would need to increase your sales by over 50% to be better off. That’s a difficult thing to do even during a boom and would probably be impossible during a recession. So what if we reduce prices by 5%? Then we need an extra 20% before we’re better off; still a tall order in a slump. These are hypothetical figures and you can calculate the effects of changing prices by entering your own gross profit margin and the percentage price change you are considering by clicking here.

Any business needs to think very seriously about price changes. Increasing or decreasing prices can have such a profound effect on a business that it is always a surprise when research studies show how many organisations set prices using cost plus methods, ignoring other approaches. Sales price setting should take other factors into account as well. How sensitive the customer is to price changes, what alternatives are there, what are competitors charging, are some of the things that need to be considered.

A price increase may cause sales to fall but this may not be a bad thing. Using the previous scenario if the organisation had put its price up by 2% and lost 5% of its sales volume as a result it would still be better off. In fact it would have to loose nearly 8% before it was worse off.

The advice to cut prices to increase sales should be ignored in many situations. It will work in a few specific circumstances but definitely not in all. Before changing prices, consider all the implications, do the calculations and the research, because you will be making one of the most important decisions for you business, its survival and its profitability depend on getting this right. Remember more businesses fail because they are too cheap than those that fail because they are too expensive.

Gordon Stewart MBA MIBC is a experienced business adviser working for CEOSTRA Ltd helping established small and medium sized businesses grow and prosper. October 2008