When competition gets tough it’s tempting to resort to discounting.
Discounting can cause huge cash flow problems for a business, and often pricing problems might be a symptom of other weaknesses in a business.
Inevitably discounting is a short-term solution with a long term impact which may devastate profits. However, it is important to consider discounting as part of managing your working capital.
The table below outlines how much more you’ll need to increase your sales by in order to make the same amount of money, based on various Gross Profit Margins and discounts. Food for thought!
Impact of a Price Discounting Strategy
Given a price reduction, to achieve the same profit your sales volume must increase by
The above table indicates the increase in sales that would be required to compensate for a discounting strategy. For example, at a 40 percent margin, a 10 percent decrease in price would require sales volume to increase by 33 percent to maintain the same level of profit.
When considering pricing strategies you need to know if your business is competing on price (low price, low margin, high volume), or are you competing on differentiation (high price, high margin, low volume). Then you need to ensure that pricing strategies match your target market. It’s okay to be priced higher than your competitors, as long as you meet your customers’ expectations of quality.
Impact of a Premium Pricing Strategy
Given a price increase, your sales could decline by the amount shown before gross profit is reduced
The above table shows the amount by which your sales have to decline following a price increase before your gross profit is reduced below its present level. For example, at a 40 percent margin, a 10 percent increase in price could sustain a 20 percent reduction in sales volume.
Mike Atkinson is business improvement manager at Bellingham Wallace.
T: 021 619 177