Should I Lower My Prices to Increase Profit?
Recently, a Catapult Groups member shared with me a dilemma I’ve found increasingly common among small and mid-sized businesses. In order to secure a large project, the member was contemplating a reduction in the price of his bid. Before getting into the larger question about the relative soundness of this strategy, I encouraged the member to look at several key variables before lowering his prices:
- Does the project under consideration represent recurring value to the business or is it strictly a one-time deal?
- Are your company’s overhead costs fixed or variable? In other words, will the overhead grow proportionally to the likely growth of revenue—or will it remain the same?
- What are the potential risks of diluting your company’s overall margin, and what’s the likelihood you’ll be left with a low-margin business? Price alone does not drive customers.
Why Can Lowering Your Price Be a Bad Strategy?
My personal conviction is that all good things come from profit. Based on my experience of running several successful businesses, I believe the single most important element to consider at all times is the gross profit margin of your company. If that’s healthy and stays healthy, the future is bright. If not, your business could be headed for serious trouble.
Cash is always king.
Every business rises or falls based on cash flow. Without cash, you can’t purchase the raw materials needed for your products. You can’t pay the rent on an office or warehouse. You can’t pay employees to sell your product, manage your business processes, and so on. A profitable enterprise generates more cash than it expends. A struggling enterprise spends more money than it takes in.
How to Maintain Profit Margin
Gross profit represents the difference between the sales of your products (or services) and the cost of goods sold. This leads to a basic fact of life that every business, regardless of size, must follow. The greater your gross profit margin, the more money comes in. The lower the gross profit margin, the less cash is available to pay for business expenses and to invest in the growth of the company.
Decide how to preserve those margins. Regardless of what the business whiz kids say, there’s no silver bullet to managing gross profit margins, only an informed decision-making process based on an objective assessment of the situation.
To maintain a healthy gross profit margin, you can either (a) cut operating expenses; (b) raise the price of your products or services; or (c) increase operational efficiency.
Whatever you sell comes with expenses attached—everything from sales and administrative costs to labor and shipping fees. The greater your expenses, the less profit you have.
Put every single business expense under the cost-cutting microscope. As finance expert Mike Periu notes, “If you can’t articulate in a clear and simple manner what a particular expenditure does for your business, then you should question whether it’s truly money well spent.”
Some business owners believe lowering the prices of their goods and services will lead to an increase in gross profit. In my experience, this is rarely the case. Unless there’s a corresponding decrease in expenses, you’re stuck with reduced profits and even less wiggle room than before to fund all the processes necessary to stay afloat. Plus, your business becomes known chiefly as a “low-cost” enterprise, which many customers associate with lesser quality.
So is raising prices the answer? For businesses with an established customer base, there’s less of a risk, as long as those customers are assured of continuity in the quality and delivery of the desired product. Plus there’s a possible increase in gross profit, which means more cash on hand to fund expenses and invest in new equipment, building renovations and so on.
Of course, along with a price increase, you must demonstrate a rigorous commitment to quality and a higher level of service than your competitors. The pay-off? A budding reputation in the marketplace as a “premium” business, offering quality customers can always depend on.
Manufacturing and delivering your products using the most cost-effective process is also key to maintaining a viable gross profit margin. This process demands constant attention to streamlining core operations while remaining responsive to changes in the marketplace.
Businesses must learn to “just say no!” to redundancy and waste, but they must also maximize the use of those resources (employees, technology, etc.) most critical to their continued success.
Commonly adopted techniques include:
- Outsourcing activities better performed by others
- Identifying opportunities for supplier discounts on bulk sales
- Getting rid out of outmoded or obsolete equipment
Remember, it all starts and ends with gross profit. Make that the key element of your long-range business strategy and good things will follow.