The Power of price increase
The goal of a business is to make a net profit – as much as possible. After all, it is the net profit that will buy the life style we are after. There are only three ways that one can improve the net profit:
The levers of business
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Sell at a higher price
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Sell more product and service
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Cut costs
Much attention is usually directed at chasing turn over and getting better discounts, whilst the easiest solution is staring us in the face. Here it is, provided the other two levers remain constant: If you increase your price by one percent, it will increase your net profit by five percent. If you increase your price by five percent, you will increase your net profit by twenty-five percent. That should illicit at least a wow or a high five!
To prove the point, here are the calculations:
Turnover and costs remain the same.
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Turnover is R250 000.
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Net profit is 20% = R50 000.
Then:
Increase the average price by one percent:
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Turnover will increase by R2 500
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Because the other levers remain constant, R2 500 goes straight to the bottom line.
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Net profit now R52 500, which represents a five percent increase!
By the same token, if the price is increased by five percent, then the net profit will increase by 25 percent to R62 500.
To illustrate how price outperforms the other levers, one can do the following calculations:
| Income statement | ||
|---|---|---|
| Turnover | 250 000 | % of T/O |
| COS (variable) | 87 500 | 35% |
| Gross profit | 162 500 | 45% |
| Fixed cost | 112 500 | 45% |
| Net profit | 50 000 | 20% |
Increase turnover by 1% = 252 500
Net profit 20% = 50 500
Increase of 0.01%
Decrease variable cost by 1% = 86 625
GP = 163 375 – 112 500 = 50 875
Net increase of 0,0175%
Decrease fixed cost by 1% = 111375
GP 162 500 – 111 375 = 51 125
Net profit increase = 0.0225%
What this calls for is pricing strategy that has a selective, transactional approach and not one that is applied across the board. Box smart and make more money!