(Warning: this post contains math. Proceed with caution.)
“We lose a dollar on each one we sell, but we make it up in volume.”
Yeah, we all know that isn’t right, but there is a mistaken belief that if you lower your prices, you can easily make up the lower margins through higher volume.
Let me show you why that doesn’t necessarily work.
First, we have to make an assumption together. Your business has fixed costs that do not change as your sales change (utilities, rent, etc), and your business has variable costs that go up as you do more volume (credit card fees, payroll, freight, advertising, etc).
DOING THE MATH
Here is some simple math…
You have an item you purchase for $10 and sell for $20. Let’s say you sold 24 of this item last year. That gives you a gross profit of $240 (24 units x $10 in profit per unit = $240 gross profit).
But you have the grand idea to lower the price 10% to $18, figuring you’ll make it up in volume.
To get the same $240 in gross profit, you now need to sell 30 units (30 x $8 = $240). That’s a 25% increase in units sold. With more units sold, however, your variable costs will go up. Maybe it is advertising because you had to spend more to get the word out about your lower price. Maybe it is extra sales people needed to help boost sales. Maybe it is more credit card transaction fees.
Realistically, just selling 25% more units won’t even break even because of the rise in variable costs. You’ll probably need closer to 30% more in units sold to cover your 10% discount.
Do you think 10% Off is enough to sell that many more units?
Okay, maybe 10% isn’t enough to move the needle. Let’s go 20% Off and sell them for $16!
Here’s the math…
40 units x $6 = $240. Yes, you now need to sell 67% more units just to get the same gross profit! More than likely, as your variable costs go up, you’ll probably need to sell about 70-75% more units to truly break even.
How about 30% Off?
60 units x $4 = $240. If you go to 30% Off, you better be able to sell 250-300% more units to make it up in volume.
That is a lot of extra traffic you’re going to need to draw, and a lot of staff you’re going to need to handle those sales.
When you do the math, making it up in volume isn’t the answer. But ask yourself this question…
If I raise my prices a little, how many sales might I lose?
A 10% price increase could handle a 17% drop in units sold and make you the same amount of gross profit.
See? Those math classes in high school can pay off!
PS Yes, you can raise your prices. With the way insurance premiums, taxes, utilities and other expenses keep rising, you have to find ways to make more money just to stay in business. But just a straight increase across the board isn’t the strategy. Download my FREE eBook Pricing for Profit in the Free Resources section to see smart ways to raise your prices (that won’t cost you a single unit sold).