What Happens to Your Profit When You Change Your Prices?
Most owners worry about raising prices because they're afraid of losing customers. Very few stop to work out how many customers they could actually afford to lose. The same goes for discounts. A 10% discount feels like a small gesture to win a deal. Most owners don't realise how much extra work it takes to make that money back.
Pricing is one of the most powerful levers in your business and here's how to understand what it really does to your profit.
Start With Your Gross Margin
Everything in this blog depends on one number: your gross margin. That's the percentage of each sale left after the direct costs of delivering it.
For the examples below, we'll use a hypothetical business with:
Sales of £100,000 (1,000 sales @ £100 per sale)
Direct costs of £60,000
Gross profit of £40,000, which is a 40% gross margin
What a 5% Price Increase Does
If you raise your prices by 5% and the direct costs stay the same. Assuming your sales price is £100, that now becomes £105. The cost to deliver is still £60, so your gross profit per sale goes from £40 to £45.
That extra £5 is all gross profit. It's a 12.5% increase in gross profit from a 5% price change.
How Many Customers Could You Lose?
Here's the question most owners never ask. How much sales volume could you lose and still make the same £40,000 gross profit?
At £45 of gross profit per sale, you need about 889 sales to make £40,000. Before the price increase, you needed 1,000. That means the business could lose around 11% of its sales volume and still be no worse off.
Usually, with less work to deliver, this gives you more capacity to find new customers and make additional profit and time to work on the business rather than in the business. When you know your numbers, it turns a nervous decision into a calculated one.
What a 10% Discount Does
Now run it the other way. The business offers a 10% discount.
This means every £100 sale now becomes £90. The cost is still £60 and your gross profit per sale drops from £40 to £30. To make the same £40,000 gross profit, the business now needs around 1,333 sales. That's 33% more work just to keep the same level of gross profit.
A 10% discount doesn't cost you 10% of your profit. In this example, it costs you 25% of your gross profit on every sale.
The Lower Your Margin, the Bigger the Effect
This is where it catches people out. The thinner your gross margin, the more a discount hurts and the more a price increase helps.
A business on a 20% margin that offers a 10% discount would need to double its sales volume to make the same gross profit. That's a lot of extra work for no extra reward.
Next time, before you agree to that discount, work out what it really means for your margin.
How to Approach a Price Review
You don't have to raise every price for every customer at once. A more considered approach works better:
Know your margin by product or service: some will have more room to move than others
Work out your break-even volume: how much work could you lose and still make the same profit?
Give notice: tell customers in advance and explain what they continue to get from you
Review the result: after 3 months, compare your actual volume and gross profit against your expectations
Make Pricing a Regular Decision
Pricing shouldn't be something you look at once every few years when costs have already squeezed your margin. It should at least be part of your annual planning, with the numbers worked out before you decide.
The businesses that price with confidence aren't guessing. They know exactly what a change in price will do to their profit before they make it.
At LedgerFix Consulting, I help small business owners model the impact of pricing decisions on their margin, profit and cash, so they can make the call with clarity rather than hoping for the best.
If you're thinking about a price review for your business, get in touch using the link below.
Ben
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