As discussed in our previous blog, it’s clear that discounting a selling price can have a huge impact on margin unless a massive increase in sales volume is achieved. But what about if you are considering increasing your selling prices?
Based on the example used below, a decision to increase the selling price by just 5% means that even a loss of 20% of current sales volume, due to said price increase, would still not negatively affect the margin.
The higher the percentage margin is, the less volume needs to be sold in order to achieve the same amount of pounds that you would have achieved if you hadn’t increased the selling price.
This is absolutely not a suggestion that you should try to lose customers! What it is saying is that if you put your price up and lost some customers, as long as you don’t lose more than the relevant percentage as demonstrated in the example above, you will have a positive impact on the overall margin £ that your business achieves within your Profit and Loss Account.
Since margins are critical for covering the overhead costs of running your business and contributing to the overall profits made, getting this right is paramount to achieving business success. However, margin on one product/service should never be looked at in isolation. It’s vital that the customer relationship is fully understood alongside this. For example, would a customer buying this product/service from you also buy others or is this generally purchased in isolation? If your customers generally buy a number of products or services from you, it’s important to consider the potential wider impact of this within your pricing tactics.
It’s crucial for stakeholders within all areas of a business to know whether the price of products or services allows the desired level of profit to be made. All the costs associated with producing a product or service need to be taken into account. The selling price then needs to be set at a level that covers these costs and allows a profit to be generated.
It’s also important to understand your customer base and how price-sensitive they are. In many industries, if a business delivers a good service at a fair price, many loyal customers will have very little objection to a modest price increase. If customers believe a product or service offers value, the selling price could be set at a level with the potential to generate considerable profit.
Of course, some customers will react to price changes and there’s a chance that some custom will be lost. If price is an overriding concern or there is an absence of perceived value, then this is inevitable. In these situations, you need to ensure that the increased profitability will offset those lost sales.
When deciding what price to charge for a product or service, the most important consideration is value. If customers can see the value of buying a product or service, more often than not, they’ll pay the price. In the absence of perceived value, a low price will make very little difference. In fact, customers tend to look elsewhere for that value, even if it means paying a higher price.
A small increase in price, and therefore margin, may allow for a little breathing time to explore alternative profitability strategies. Working on ways to reduce costs without losing perceived value may be one such approach. In doing so, a business will ultimately be able to remain competitive while maintaining the same level of financial success.
One last thing to be aware of – different organisations may have a variety of ways of describing the term ‘margin’. Watch out for the use of different words and phrases such as ‘gross margin’, ‘gross profit’ and ‘contribution’ as these can all be used to describe the same thing!
These examples are taken from our Finance for Non-Financial Managers course.
Finance for Non-Financial Managers
These techniques are covered in more detail in our Finance for Non-Financial Managers course.