Would you like to make a lot more money without working any harder at all? One of the things I love about Chief Executive Boards International is the window I have on leading-edge trends in mid-sized businesses. The entire reason for this blog is to share those with you in near-real time.
I'm just recently hearing from CEBI members and other business acquaintances that they're starting to creep prices and they're holding. I'm not sure of the reasons for that, but a few possibilities come to mind.
- As the economy continues to perk up, commodities prices are rising, particularly metals
- There's lots of talk about inflation (although I think it's not imminent)
- Prices in most industries haven't moved in quite awhile
- As your customers businesses improve, they can tolerate your price increases
- In many industries, capacities are down and supply is tightening up
Let's say your business is doing well -- producing a 10% pretax net on sales. So, for $100,000 in sales, you clear $10,000. In that model, to grow your net profit $1,000, you have to grow your sales $10,000, right? That's finding 10% more orders, using 10% more labor, 10% more raw materials, and increasing your working capital by 10%. Working 10% harder.
Let's consider the alternative -- a one percent price increase. Sell the same $100,000 worth of product for $101,000, and what happens? The price increase drops all the way to the bottom line -- friction free. No more labor, no more material, and nobody has to work any harder. Yet your net profit increases by 10%.
What if some customers won't buy at the higher price? One clever member did the math really quickly, noting that if you raised prices 3% and lost 20% of your volume, you'd still be ahead. How? At $80,000 in revenue, you'd expect to make $8,000. With a price increase of 3% on the remaining $80,000 in revenue, you're selling it for $82,400, and your net becomes $10,400. With 20% less of everything required.
Now, this is an admittedly simple example. For one thing, it assumes all costs are variable costs. Nevertheless, if you can start creeping prices, even on part of your products or services, you'll be surprised at the impact on your profitability.