Should I drop my prices to keep my volumes up?
Lisa runs a very exclusive bespoke celebration cake business. The noise about the faltering global economy and the potential local impact got her thinking about actions she could take now to protect her business.
One of Lisa's ideas is to lower her prices to stay "competitive" and she asked me what I thought of this strategy.
I started by asking Lisa four key questions to help her decide whether across the board lowering of prices is a good idea. She found them useful so I thought I would share them here.
1. What do you want to achieve by lowering prices?
Lisa said she wanted to maintain her current gross margin so that she could continue to afford the infrastructure of the business. She hoped that the drop in selling price would increase her sales volume enough to continue to yield the same gross margin.
2. If you decrease your selling price by 10% by how much will you need to increase volume to compensate?
This wasn't a trick question but Lisa, like many businesses, hadn't done the maths. She was surprised to learn that a business with a 50% gross margin that dropped its prices by 10% would need to increase volume by 25% to compensate. When Lisa ran her numbers she was shocked by the increase in volume her business would need to maintain gross margin at the reduced selling price.
3. Do you think there is sufficient demand for your product to warrant a new model of lower price/higher volume?
This was an important point for Lisa. Her business is pitched at a small exclusive clientele – total volume (the number of functions) is likely to decrease in a wobbly economy so for her business to increase volume by, let's say 25%, she would have to chase an increase in her share of functions by 50% or more. A tough ask at the best of times and of course, an increase of such magnitude would involve much more sales and marketing effort.
4. In which ways are your clients price-sensitive?
When Lisa thought about this question she realised that a 10% decrease in selling price wasn't going to make much difference to her clients. The demand for Lisa's cakes depended on the number of high-end functions. The number of functions was likely to drop given the wobbly economy, but for those customers who made the choice to go ahead, the cost of the cake was a small part. A 10% discount off a small component in the function cost was unlikely to be noticed by the customer but would be felt dearly by Lisa.
After considering her answers to the questions Lisa realised that if she lowered her selling price she would probably just wind up with a lower gross margin and in all likelihood be discounting to clients who would happily pay top dollar. Not a good strategy!
Instead Lisa has decided to offer a "diffusion range" – a top-quality-off-the-shelf cake range. That way she can offer a significantly lower priced product without impacting her exclusive bespoke cake clients.
Julia Bickerstaff's expertise is in helping businesses grow profitably. She runs two businesses:Butterfly Coaching, a small advisory firm with a unique approach to assisting SMEs with profitable growth; and The Business Bakery, which helps kitchen table tycoons build their best businesses. Julia is the author of "How to Bake a Business" and was previously a partner at Deloitte. She is a chartered accountant and has a degree in economics from The London School of Economics (London University).