Are you priced for profit ?

You already know that as a CEO or a manager of a business or a division you have four levers available to you that you can manipulate to change the trajectory of your company or division’s profitability. These levers are

1. Increase Sales

2. Reduce Variable Costs

3. Reduce Fixed Costs

4. Increase Price

Pretty straight forward. However, it is noticed that most managers are focussed on cutting costs as a way to improve profitability. And fixed costs tend to find most favour, as this is a constant and most visible. Increase in sales comes naturally but not always from the perspective of increasing profitability. Many a times it is a stand alone metric in the KPIs and not linked to corresponding KPI on containment, management or reduction in cost of sales. With no metric in place if the cost of sales increase disproportionately, profitability remains an illusion. Smart mangers keep a check on the variable costs and are aware of its impact on profitability. The least favorite of all the levers - increase in Price. 

Apparently, more levers to manage show more is being done and is easier to accept than a single metric of increase in price. A price increase may be considered as the easiest thing to do when actually it is not!. It is a double edged sword. Lets look at the corresponding impact on profitability for a 1% change in each of these four levers.

As per study done by Mckinsey on Global 1200 and those done by Wharton Research Data Services, a 1% reduction in Fixed Cost, without impacting firms operation, the impact on profitability averages around 2.5%.

If the firm increases its sales volume by 1% without impacting its cost structure the profitability impact is around 3%. If the variable costs can be lowered by 1% the impact is even larger at about 6%. That is a very decent increase. However, here is the kicker. If the firm can increase its price by 1% the profitability leaps with a double-digit increase of about 10%! But this still remains one of the least favorite levers. The oft-cited reason – sales drop.

The risk averse easily accepts and moves to the less effective levers. Here is an opportunity to stop and rethink about the industry you are in – suppliers, capacity, competition, distribution channel, consumer behavior, segmentation etc. There might be an opportunity to increase price as industry capacity is limited, excess capacity rests with you, certain set of customers can be sold at an increased price, product / service can be bundled/unbundled and priced more creatively.

There will be arguments on both sides. There is a risk and there is a reward. Evaluate yours. There is usually an opportunity to do a deep dive or simply think creatively and price your product or service for profitability.

An opportunity to have a double-digit increase in profitability must not be missed. Give that profitability upside a shot or at least start evaluating whether your product / services are priced optimally for profits.  As Peter Drucker said, Profitability is the Sovereign Criterion of Enterprise.