It’s easy to set your price so that you don’t lose any customers. But will this give you the maximum profit? Here’s a graph to help you think about it
If we line up all our customers in order of how much they will pay (even though we’ll never know this for sure!) let’s imagine it’s a gradually increasing line up, shown by my vertical line shape.
If we charge the price that the lowest customer will stand, we price at the red line, and if the blue line is our costs then the rectangle between them is our profit.
But what if we put our price up a bit?
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Well, all the customers below the intersection point will say “I’m not paying that” and leave, but we will make more profit from the others (who all still think we are cheap – they would have paid more). The big question is “Does this profit outweigh what we have lost?
The amount we gain is the yellow rectangle on the right – we are charging more to half our customers. The triangle above it is money we could have made from those people but we haven’t charged enough to get that – never mind!
The amount we lose is the yellow rectangle on the left – all the profit between the old price and our costs, that has now gone. The triangle above it is money we weren’t getting before (we didn’t charge enough) and we’re not getting now (the customers have gone).
We have lost more than we have gained!
But if your costs are higher – and normally they ARE – it’s a different picture:
Leaving aside fixed and variable costs for the moment, most companies only make 10% net profit if they are lucky, so costs are 90%, and as you can see (above) the amount we gain by pricing out half our customers is greater than what we lose (even before you start on the fact that the price obsessed customers are often more trouble than the others too!).
There IS a limit to the price increasing though:
You can see from the above that we have lost so much that even the big gain from the others is not enough.
So where is the optimum point? I think it’s probably at the 50% point – I’m not good enough at maths to be able to prove it but I do suspect it.
Clearly the angle of the slope (also known as elasticity of demand) does affect it, and there are questions of whether the line is straight or not in real life (is it an S curve?), and then there’s the question of fixed costs and marginal pricing (just getting work in to keep the fixed costs occupied, sometimes known as ‘contribution’) – but still, I think this diagram says you should be losing approximately half your business on price.
Here’s a summary diagram of all that:
Don’t take my word for it but do the analysis yourself, on your real figures, using estimates of what you think people might pay, (even do some experimental pricing maybe), and see what you get! And let me know, I’d be interested to hear from you.
Onwards and upwards!
Chris
I have been receiving your e mails for many years. I always read and enjoy them. I have now retired so some are no longer relevant to me . Others definitely are and some are pass on to my children who are now in the workplace.
I am new here. I look forward to being pleasantly enlightened about many things.
This is the first tip I receive being a new subscriber of your webpage! And it’s really practical and interesting! Thanks Chris! Would you mind if I share on Linkedin, of course mentioning you as author?
Feel free to share it as much as you like! CC
Chris, rock on! This is my first email. However, I found you on Lynda and almost met all my PDU’s watching your videos.
No I have others in our company doing the same with great enthusiasm.
Thanks for sharing your wisdom and knowledge…
Stuart
what if the seller start with price 2 (Higher price) gain a higher profit of short period of time and then lower to price 1. would that satisfy all.
yes, could do that, though you lose the longer term profit. But all combinations are possible and allowed! CC
I just completed the training “Leadership: Practical Skills” through Agora platform. It is an amazing training that I would strongly recommend for any supervisor, manager or leader. Many thanks Chris !
Hi! Due to the Covid19 Pandemic, we are staying at home. I just finished the “Leadership:Practical Skills” through LinkedIN. I already recommended the training to my friends and colleague. Big thanks Chris and more power!
Hi Chris, thank you for adding me to your mailing list. I will definitely share your valuable tips with my team members. Thanks again and stay safe !
Hi Chris,
I’m not a pricing professional, but I think there are lessons to be learned from airlines and hotels in terms of dynamic revenue management. Your examples suggest that there can only be one price, but we know very well that hotel rooms and airline seats get sold at a very wide range of rates, for the same night or flight. Additionally, your product or service does not have the same subjective value in the eyes of each customer, so why offer it at one price?
If your business allows for more dynamic pricing and you can leverage customer segmentation insights, you could attempt to maximize the total revenue by offering more differentiated rates per customer, or some kind of “staircase” of rates as you move to the right in your graph. Your rate becomes a reflection of a customer’s willingness to pay, which in turn reflects their perceived value of what you offer. It won’t work for all businesses or markets, but it is worthwhile considering.
Thank you very much. This is my first tip and am looking forward to check all other small tips you give! I’ll share them on LinkedIn with no doubt.
Stay safe,
Chiara
Am new here, am looking forward to be enlightened. Thank you Chris.