Ask yourself: “Will you make more or less profit?”
The answer is, it depends on how much new business you think you can win and your current gross margin. The chart on the right is called an iso-Profit table. It tells you the percentage change in customers you need for a certain percentage change in price, assuming a specific gross margin. Let’s go through an example.
You have have a product with 50% gross margin and you are considering lowering your price 10%. This table says you need 25% more customers just to make as much profit as you currently do. So before lowering your price, do you believe you can grow your sales volume by 25%? Not an easy task.
On the other hand, if you consider raising price on your 50% gross margin product by 10%, you can lose 17% of your customers and still break even.
Look at the 25% gross margin column. Lowering price by 10% requires a 67% increase in sales volume. It is obvious why you wouldn’t want to lower prices on low margin parts. In fact, you could raise prices by 10% and as long as you lose fewer than 29% of your customer you will make more profit.
The cells with N/A mean it’s impossible to make up the profit. For example, if you have a product with only 25% gross margin and you lower the price by 30% you lose money on every item sold. It is impossible to make up the profit you had at 25% gross margin.
The lesson for today – Do not lower (or raise) prices without an estimate of its effect on your sales volume. Then determine if you will make more or less profit at the new price. Yes, there may be strategic reasons you want to make less profit on an item, but at least go in expecting a drop in profit. Then you can be explicit on how you will make up that profit elsewhere.
Mark Stiving, Ph.D. – Pricing expert, Speaker, Author
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