Ask a business owner what their number one priority is and most will answer growth. One of the easiest ways to grow revenues and profits is to increase prices. However, most companies are understandably reluctant to do this for fear of losing customers. Before the idea of a price increase is dismissed, it’s worth taking a closer look.
Businesses that operate in highly-competitive, low margin industries where price is the primary driver of demand are generally locked into prices set by larger producers. For these companies, you have to be cheaper or offer more for the same price in order to maintain and grow volume. However, in markets where cost is not the sole factor in a customer’s purchasing decision, price can be an effective tool to grow revenues and profits.
Benefits of a successful price increase include:
Easier (and less costly) than growing through new customer acquisition
Most, if not all, of the increased profit margins falls to the bottom line
Immediate working capital benefits
Competing on “value” is more sustainable and profitable than on price alone
Rationalize low-margin customers to make room for more profitable accounts
Analyze Before You Act
The key to a successful price increase begins with a thorough analysis of the competitive landscape, the perceived value of your product and the financial impact an increase will have under various scenarios.
Understand Competing Products
The first step in any pricing analysis is to understand the products you are competing against. In addition to price, the competitive analysis should closely examine all tangible features of alternative products, as well as intangible factors that impact “perceived” value such as quality, service, availability, ease of use, reliability, country of origin, etc. Finally, it is important to note the history of price increases implemented by your competitors (i.e., how recent, how often and in what increments).
Once the competitive analysis is completed, it’s time to gauge the “perceived” value of your product relative to its peers. In other words, how is your product differentiated from others – or what is its “unique selling proposition” (to learn more about the concept of product differentiation see our previous white paper “What’s Your Unique Selling Proposition?”)?
Financial Impact Analysis
With any price increase, there is a risk of losing some customers. However, the benefit of increased revenues and profit will often outweigh this risk. It is important to quantify the breakeven volume required to sustain a contemplated price increase. For example, ABC Corporation currently sells 10,000 widgets at $100 per unit, which generates gross profit of $400,000. A price increase of 5% (to $105 per unit) would result in an increase of gross profit to $450,000 assuming no volume is lost. In order to maintain the same level of current gross profit, volume could decrease by 11.1% to 8,889 units. This is the “Breakeven Volume” for the contemplated increase.
This same type of analysis can be used in a competitive price situation where a lower price is being contemplated to gain more volume. It will tell you what additional is required to breakeven at the contemplated lower price.
Before dismissing a price increase or jumping to the conclusion that implementing one will be detrimental to your business, take a moment to consider the upside and quantify the risk associated with the move. You may find that a price increase will provide you with a substantial improvement in your cash position, which can be used to fuel growth through higher volumes.
The team at Kaplan CFO includes professionals with vast experience in financial analysis, competitive benchmarking and profit maximization. Clients can access this resource either as part of an embedded CFO engagement or on a specific project-basis. Contact us to learn more about revenue enhancement strategies and how they might help to achieve your growth objectives.