Increasing profits – should I go for increased sales or higher prices?

It is an age-old business dilemma: would I make more profit if I lowered my prices to sell more, or should I actually increase prices, accepting that I might sell slightly less? If the market will stand it, you could even do both.

Before you decide where to put your main focus, you need to understand why customers buy from you in the first place. Few businesses sell on price alone. After all, you don’t necessarily buy the cheapest car, or go to the cheapest dentist. When people buy a product or service, they often choose with their emotions and then justify their choice with logic. Price is only one small part of the equation, though an important one. You generally seek value for money. This can include tangibles – e.g. one widget for £1 – as well as intangibles such as good technical support and good customer service. 

What are customers buying?

So what is it your customers are actually buying? Before you consider whether to build your business by increasing your sales volume or prices, you need to do some research. How well do you know your customers? How often do they buy and how much do they spend on related products? Do they buy from you because of your:

• Convenience?
• Expertise?
• Service?
• Credit?
• Exclusivity?

What premium are they prepared to pay for any of these?

What are the market’s prospects?

Next, you need to consider the market’s prospects. What is happening to your marketplace in general? Is it growing or declining? What untapped sectors of the market are there to expand into if you were to go down the increased sales route? How could you persuade people to increase the quantity and frequency of their current purchasing?

Who are your competitors and what are their strengths and weaknesses? How do they compare with you in terms of products, services, prices and position in the marketplace?

Volume vs. price

The effects of volume versus price strategies have a direct effect on the bottom line. Seeking to increase your sales can be a good policy, provided that there is an unfulfilled demand for what you sell. But remember that increasing sales volume will always carry a cost. Usually, the more you sell, the more staff you need to handle the customers. You may also need to spend more money on advertising, and hold more stock, thus tying up cash.

If you adopt a high price, sales volume will usually fall away, eventually negating any higher margins. However, the effect near your break-even point is dramatic. For example, say you sell widgets that cost you £20 each, and have overheads of £1,000 a month. Let’s assume, for simplicity, that your overheads remain constant. If you sell your widgets at £30, you must sell 100 to break even.

If, on the other hand, you choose to keep a low price and rely on increased volumes, you will have to work a lot harder to make the same profits.

* Larger premises required to accommodate the extra staff.

Extra sales or extra profit?

Each business has its own rules and circumstances and sometimes you may not have any control over your price because it is a commodity market. Or at least you don’t think you do. However there is almost always some way or other of differentiating yourself from the crowd by adding value to your offer and hence charging more. But what are the benefits of either strategy?

The pros and cons of increasing sales vs increasing prices

Creating an overall pricing plan for your business

Setting the right price for your products or services is vital. You need an overall pricing plan for everything you sell, rather than a one-off calculation for each new item. (Windfall opportunities are the exception to this rule – see below.) A good pricing plan will form part of your overall marketing plan.

The simplistic view of pricing is whether you go for high-volume items with a small mark-up (‘pile ’em high, sell ’em cheap’) or quality items with a large mark-up and high price (‘charge what the market will bear’). However, unless you actually are in a business where cheapness is essential, it is almost impossible for a smaller business to compete on price with the big corporates. Larger businesses have the muscle to negotiate big discounts and handle the volumes required to make enough gross margin to cover operating costs.

Perhaps the best policy is to remember the old saying, ‘Turnover is vanity, profit is sanity’ and opt for ‘what the market will bear’. Whatever customers say about wanting cheaper prices, they also put a value on service, expertise, convenience and friendliness, for which they will pay a premium. Many marketing experts believe that small firms tend to under-price themselves, while both under-estimating their running costs and under-valuing their own worth and the personal service they offer.

What are you worth?

Or rather, what do you want to be worth?

Say you run a service business and, simply put, you want to earn £250 a week but can only work up to 40 hours a week.

Promotional costs aside, you could work for 25 hours at £10 an hour or 40 hours at £6.25 an hour. The former would give you 15 hours a week to drum up more clients while the latter does not even give you time to organise your own paperwork, let alone do any marketing.

You could justify the higher price because you could more easily guarantee a quick and reliable service. After all, you have more slack time in which to handle customers’ urgent requirements.

One accountant, Derek Williams, says, ‘The problem with unprofitable customers often dates back to when they were first recruited. Many firms discount or under-quote to close a first sale. Then they fear losing that customer too much to risk raising their prices realistically over the years. When I started to increase my own prices, to my surprise, I began to attract a better quality of customer. I gradually doubled my hourly rate over two years.

‘Yes, I lost some customers, but service not price became the issue. If you raise your prices 10%, you can probably afford to lose up to 25% of your clients. However, if you sell your benefits better, and possibly offer a guarantee, it is unlikely that you will lose that many.’

Pricing strategies

There are many recognised pricing strategies. They include:

Cost-plus

Cost-plus is the simplest strategy, where you take the cost of what you sell and add a standard percentage mark-up to arrive at your selling price.

As long as you regularly reassess both that mark-up percentage to ensure it is a true reflection of your fixed costs, and that basic cost (most important when you manufacture what you sell, as manufacturing costs change frequently), this strategy works well enough, or well enough in situations where you have a narrow product range. Where you are dealing with a wide and varied range of products, you will need to have an equally varied range of mark-up percentages.

Another problem with the cost-plus strategy is that unless you build an escalator into your mark-up, the only way you can increase your overall profitability is by selling more, with all the additional costs and work this involves.

Historical

This is also a simple method – taking the price and increasing it by a fixed percentage. It is a strategy much used by service businesses, and can work well provided that the percentage increase is recalculated every time, to take account of all factors. However, there is a tendency for prices to get badly out of line over time, so it is important to check your prices regularly against market rates.

Competitive

This works on the basis of the prices charged by your nearest competitor(s) and charging a little less. Whilst their prices will help you understand what the market will bear, unless your products or services are sufficiently different to your competitors’ to give customers a real choice, you risk a cut-throat price-war which reduces your profits below an acceptable level and might even destroy you completely.

Alternatively, you can aim to be just a little bit more expensive, but differentiated in some valuable way.

Product life cycle

All products go through a life and price cycle. When first introduced, they have a novelty value which trendsetters are prepared to pay high prices for. Then, as the product becomes commonplace, the price customers are prepared to pay for it goes down. Hopefully, the manufacturing costs go down, too.

However, another strategy is to set prices low from the start and try to corner the market before competitors arrive in the market. Setting low prices to stimulate demand in this way is called penetration pricing.

Market demand based

This simple rule is often expressed as ‘high demand allows high prices, low demand requires low prices’. But it is linked to availability and should actually be ‘high demand plus low availability allows high prices, low demand plus high availability requires low prices’. Examples are gold and sugar.

Marketing based

Market-based pricing is linked to the marketing of the product. The classic example of this pricing is the cosmetics industry, where the products are cheap to make, but are highly priced because the marketing effort has created a consumer perception that justifies the high prices. In the case of cosmetics, what is being sold is not stuff you put on your face, but something which will make you feel more confident and more attractive.

Differential (or selective) pricing

Differential pricing involves charging different prices for the same item, depending on the market segment it is aimed at, such as an old-age pensioners’ day at the hairdressers, matinee tickets at the theatre or holiday prices reflecting the peak demand times.

Windfalls

Another situation where you need to be flexible is the sort of windfall opportunity where you are asked to supply an unexpected bulk order at a heavy discount price. The key to deciding whether or not to accept the order is whether you are operating at full capacity.

• If you are, the only way you can fill that order is to pay overtime rates, so increasing your costs and reducing your already meagre mark-up.
• If you are not, and are actually paying people to stand around, the full cost of their wages plus other fixed costs such as heat and light have already been accounted for in your normal production and therefore doesn't need to be counted at all in this extra batch.

However, when you have reached your production capacity, it is time to consider restricting sales at low prices, or cutting out less profitable products. You should think very carefully about taking on extra business at low prices.

Pricing services

In general, there is no difference between pricing products or services. Both are only worth what your customers are prepared to pay for them, and that is based on their perception of value.

With services, however, you are essentially selling time – that of yourself and your staff. If you are a one-person-band, the only way you can find more time is to work more hours, which inevitably means the quality of your service and/or your personal life will suffer. And there are only so many hours in a day.

At this point, to sell more, you have to start delegating to people you recruit or to sub-contractors. Meanwhile, you can outsource non-core functions, such as your book-keeping, leaving you free to work for clients.

The economics are simple. Ask yourself:

• Will this cost me less than the £x/hour I can recover myself from doing the extra work for clients?
• Or, will this add value to my service so that I can charge more?

The simple rule when you are working at near capacity is to raise your prices – you are probably under-charging.

Strategies for increasing prices

Price rises are normal, so never apologise for them and treat them as routine. When increasing prices, bear these points in mind:

• Don’t do it too often, and do it in small increments. Everyone accepts that prices have to rise sometimes, but they tend to think big price hikes are profiteering. Price rises of, say, 5% a year for five years will be viewed more favourably than a single 25% rise after five years. No one appreciates your restraint over the years – customers simply object to the immediate rise.
• Give your key accounts plenty of warning. For example, you might give notice that you will raise your prices, allowing customers to buy at the existing price for a short while.
• Increase them at the same time as your competitors. If you leave it in the hope of gaining extra sales while your prices are competitively low, it will be more noticeable when you do have to do it.
• Don’t increase all your prices at once and, ideally, reduce the price of some items at the same time.
• Look for opportunities to increase value when raising prices, for example, by including free extras. You might include some follow-up activity free, which could in itself provide a chance to sell more at a later date.
• Repackage the extras. You might exclude some of the ‘free’ extras and charge for them instead, such as delivery.

Increase your margins

Increasing your prices is only one avenue you should explore. The other one is to drive down your costs. Look for ways to:

• reduce the costs of sales and your overheads by negotiating better deals with your suppliers,
• streamline how you operate, for example, by outsourcing more and hiring freelance skills on an as-needed basis,
• operate more efficiently, for example by sub-letting spare office capacity or finding a cheaper phone or utility supplier.