Should we cut our prices?


Price is unquestionably the most powerful growth driver.  You absolutely must get this one right.  The wrong price is the single biggest reason why UK businesses struggle or even fail.  But when you get the price right, you’ll transform your business overnight.  You might be surprised at how and why this happens.

Cutting prices can be disastrous

Most businesses are in competitive markets, so they will often say something like, “We need to reduce our prices to stay competitive and win more customers”.  After all that will bring in new customers, won’t it?

Well yes it might do that.  But wait a moment before you rush of to change your prices, you must first understand the numbers.

Let’s look at a fictional example of Mooredge Decorators:

Mooredge Decorators
Annual sales

£750,000

Gross profit percentage

28.93%

Gross Profit

£217,000

profit in accounts

£27,500

Market salary

£25,000

True profit

£2,500

 

If they reduce their prices by, say, 20% in the hope of getting more customers, and if they in fact get 20% more customers (and thereby increases the amount they sell by 20%) then this will in fact reduce their profit by £136,600.  (cutting prices by 20% reduces sales from £750,000 to £600,000.  However, getting 20% more customers increases sales from £600,000 to £720,000, so sales fall by £30,000.  Also, with 20% more customers, his direct costs will increase by 20% from £533,000 to £639,600.  That’s a staggering £106,600.  Add to that the £30,000 fall in sales, and we get a reduction in profit of £136,600).

So how many more customers will they need just to make the same £2,500 profit as before the price cut?

If Mooredge Decorators’ prices are cut by 20%, the company needs an extra 223.88%.  Even if they did achieve 223.88% more customers, even that will yield no extra profits, no growth at all.

So, ask yourself this… Are you remotely likely to win that minimum number of extra customers?  If the answer is “No”- or even “probably not”- then cutting your prices is not a good idea.

Cutting prices doesn’t just affect your profit

Price-cutting is obviously not a good idea for your profitability.  But it’s not a good idea for your cash flow either.  To make more profit at lower prices, your sales must be higher than they are now.  And that means more money tied up in stock, work in progress and debtors- and more strain on your cash flow.

So think very carefully before you cut your prices.  Check the consequences, because they could be devastating.

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