Reducing Prices is not the miracle cure you might think!
Posted on 19th Jan 2022
Recently I spoke about pricing and mindset and what increasing your prices can do for your business.
In this article I thought I would share the opposite side of the coin.
I often hear business owners stressing over trying to grow their businesses. Most start by thinking they need more turnover. In truth 85% of business owners don’t really understand their numbers and how everything hangs together. So, they measure their business success by turnover and bank balance and pay little or no attention to the costs and margins and net profit!
In truth, they leave business to chance instead of having a clear picture of what needs to be done.
Does being the cheapest really work?
I want to dispel a myth that the way to be successful is just to get more sales and that,the only and best way to do this is to reduce prices and be the cheapest.
In a very small number of cases this may work, if you operate in a commoditised market and there is nothing to differentiate you from the competition.
In reality though this is rarely the case! If you do decide to go down this route, you need to make sure you have the leanest, most cost-effective business you can or else it’s a race to the bottom and worse still – you could go out of business!
Value for money
Luckily for the vast majority of business owners, people don’t buy on price they buy on perceived value for money!
You only have to look around at the vast array of clothing retailers from Primark to Gucci and everything in between. Primark clothes are perfectly ok and are fit for purpose, but the quality and fit are very different to a Gucci garment or pair of shoes.
However, both brands know their ideal customer and they are not the same person. One piles it high and sells it cheap as a business model, the other prices high and sells relatively few products.
Know what you want!
You need to have carefully thought out your business model which includes: –
- Who is your ideal customer?
- How will you market to them?
- What problems does your product or service solve?
- What does your ideal client want from your product or service?
- What disposable income do they have?
- What will they be prepared to pay?
- Do they want a quick fix or are they looking for something that will hang around and still be of use in years to come?
- Does the business generate enough cash for you to live your life?
- What does your operation look like in terms of people, premises, skills, and cash available?
- What are you not prepared to do!
What effect does discounting the price have on your profitability?
Most business owners who don’t have a real handle on their numbers think that by reducing the price they will attract a lot more customers and make a lot more profit. In reality though this rarely happens.
It does depend on your Gross Margin in terms of how much you will need to sell to generate the same level of profit.
If you’re Gross Profit Margin is 40% and you decide to give a 10% discount you will need to sell 33% more products or services to generate the same profit.
Now that’s going some!!
The increased demand can be fraught with problems delivering
- This could result in additional strain on your cashflow as you may need to buy more stock or rent warehousing space to store it until it’s shipped
- You may need more people to deliver the extra work which you hadn’t anticipated or factored into your profit forecast
- It may take longer to source the raw materials or time to produce the product or service
- This may result in unhappy customers as they are now having to wait longer for the service or product!
- Equally it can put strain on production of the product or service as mistakes may be made due to the increased volume and results in re-work which is wasted money and therefore profit down the drain
- The stress of trying to deliver this increased volume when you don’t have the operational capacity to deal with it
The moral of the story is to think carefully about your business model, cost it out and be sure you know your numbers if you are going down this route.
If you would like help pulling together a profit forecast or devising a scorecard so you know and can easily monitor your numbers drop us an email at firstname.lastname@example.org or call us on 0161 410 0020.
Until next time I’ll leave you with the following analogy…