Higher Prices Lead to Higher Profits

by Paul Lemberg

Published on this site: September 28th, 2005 - See more articles from this month

I know at first glance this sounds obvious, but it may be worth it for you to think about your prices. At least just for a moment.

How did you decide on your current pricing? Did you conduct market research to understand what prospects would pay? Or did you compare yourself to your competitors and base your price on that? Or was it a crapshoot, and random shot in the dark?

These are the ways most people do it, and they are all wrong. Because the price you set for your products and services is more important than you think.

The following few paragraphs are a bit number heavy, but stay with me because this will be really valuable for you to understand.

Let's say you sell a high margin product - information products and software are two good examples. Your price is $60, and your costs are $10 - that means your gross margin (selling price - your costs) is $50 each time you sell one unit. Let's say further that your overhead is $5,000 per month. If you sell 100 units you'll break even, right?

Now you want to sell more, and decide you can take some business from a competitor by lowering your price - temporarily. You lower it to $40 - a 33% price cut, and not uncommon.

Your costs remain $10 and your overhead is still $5,000, only now your gross margin is $30 - 60% of what it was before. And how many units do you need to break even now? 166! That's 66% more unit sales required to make up for the 33% price cut!

But what if you're feeling very aggressive and you cut your price in half (also not unheard of) to $30. Now you have to sell 250 units - just to break even! That's 2-1/2 times as many as before. How easy do you think that's going to be?

Let's use a different example - something that has real manufacturing costs. This time, your product sells for $100, and your cost of goods are $50 per unit, for a gross profit of $50. Same $5000 overhead, same number of units to break even. Now imagine you cut your price 20%, to $80, leaving you with $30 of gross margin. You need to sell 66% more units. Ouch!

What if you cut the price to $70. This 30% price cut means you have to sell 2-1/2 times more units - just to stay even.

Let's go further...

Competition is really heating up and you think that matching them cut for cut is the way to go. The price for this amazing widget of yours is now a bargain basement $60.

(Shucks, that's only 40% off your original price. Salespeople and business owners do this every day.)

How many units do you need to break even? 500.

Five hundred? That's five times your original number.

Do you really think you can sell five times what you did before - at least without significantly raising your overhead and your variable cost of sale?

How many times have you done just this in response to competitive pressures?

How many times have you cut prices because you thought it would help you sell more?

What we've just done is a simplified version of what's called margin analysis, and I hope it gives you a glimmer of what can happen when you mis-price.

For the most part, your price cuts don't automatically enable you to sell 66% more than you did before, and generally - at least not in this universe - you don't sell 250% more, and never, ever do you sell 500% more with this kind of price cutting.

But there is some good news - and it's very good.

Let's look at what happens when you raise your prices.

Remember your high-margin product. It sells for $60 and costs $10 to make.

Through good product positioning and excellent marketing you raise the price to $70. That's only a 15% increase. Now you only have to sell 83 units to break even, and if you sell the same 100 units, your profits go from $0 to $1000. Nice increase...

And that "hard" product - the one with $50 of costs? Raise the price tag 20% to $120, your margins increase to $70, and now your breakeven drops 71, and you make $2000 if you sell the same number of them.

See how this works?

You can do this same analysis in a bit more sophisticated way, considering your marketing costs, sales or affiliate commissions, travel expenses if you have them, and so on. You can see the actual pricing effect varies quite a bit depending on these details.

If you have a high-leverage, pay-only-for-results affiliate model, a very high gross margin and almost no fixed overhead, you have a lot of price flexibility. You can cut the price 25% and only need to sell 15% more! That's not too bad at all.

But only in that type of model. If you have a office, some staff, and a physical product - in other words, fixed overhead - lower prices can kill you - and you won't even see it coming.

And higher prices?

They can make you rich.

By now you are starting to see the tragic effects of mis-pricing on the downside, and the marvelously enriching possibilities of raising your prices.

This only works, of course, when you can also increase your value proposition...

Stay tuned for part 2.

Follow this link at the bottom of the page to get a copy of an excel spreadsheet to play with. Get the spreadsheet, plug in your own numbers. It will really blow your mind. Also, feel free to pass this article or the spreadsheet on to your friends and associates. They will definitely appreciate it.http://www.paullemberg.com/higher-part1.html

Paul Lemberg is the President of Quantum Growth Coaching, the world's only business coaching franchise system built from the ground up to rapidly create more profits and more life for entrepreneurs. http://www.quantumgrowthcoachingfranchise.com Paul is also Executive Director of the Stratamax Research Institute, a business coaching and consulting firm specializing in helping entrepreneurial companies quickly increase short term profits for sustainable long term growth.