The pricing strategy of a small business often determines the ultimate success or failure of that business.
Small Business Owners commonly set prices with a view of being the cheapest in the market, with no consideration as to the total costs involved with delivering their product or service.
The following factors should be considered when setting prices:
- The total costs involved in providing the product or service, including cost of goods sold and overhead expenses
- Competitors’ prices and the quality of their product or service compared to that of yours
- The supply and demand of your product and service. For example, you are only one of limited suppliers of a product you have more control over the price that you set for that product.
- The planned position of your business within the market. Is your business placed at the top end of the market with superior quality and value-add features or do you aim to offer cheaper alternatives focusing on a high volume of turnover?
The following scenario demonstrates how a price increase of just 1% can impact on the bottom line, compared to increasing sales volume by 1%.
Table 1 – Increase in Sales Prices by 1%
|
Initial Turnover |
$100.00 |
1% Price Increase |
$101.00 |
|
Less: Cost of Goods Sold |
($60.00) |
Less: Cost of Goods Sold |
($60.00) |
|
Gross Margin |
$40.00 |
Gross Margin |
$41.00 |
|
Less: Overheads |
($32.00) |
Less: Overheads |
($32.00) |
|
Net Profit |
$8.00 |
Net Profit |
$9.00 |
Table 2 – Increase in Sales Volume by 1%
|
Initial Turnover |
$100.00 |
1% Volume Increase |
$101.00 |
|
Less: Cost of Goods Sold |
($60.00) |
Less: Cost of Goods Sold |
($60.60)* |
|
Gross Margin |
$40.00 |
Gross Margin |
$40.40 |
|
Less: Overheads |
($32.00) |
Less: Overheads |
($32.00) |
|
Net Profit |
$8.00 |
Net Profit |
$8.40 |
* Cost of Goods Sold increases by 1% due to the increase in volume of products being sold.
A 1% increase in prices results in a 12.5% increase to net profit, whereas a 1% increase in sales volume only increases net profit by 5%. This doesn’t take into account the extra time and effort involved in generating the additional 1% volume of sales.