Price increases are always a tricky thing and it is tough to know what direction to go. You can increase cash flow but as you start to think about changing your prices, you ask yourself: “What will my customers think? How many of my customers will I lose to my competition if I do this? Is now the right time?” All of these emotional thoughts are battling with the rational side of your mind as you think: “My vendor costs have gone up, my margins are slipping and I may need to lay off someone if I don’t do something.”
I assume some version of this sounds familiar to many of you. I’ve seen these conversations take place in large public companies, in startups and in all types of business in between. The result is usually the same and no action is taken. It’s because we are all human and generally like our customers. We also are so invested in our companies and products that any rejection is personal. Reducing the chance for rejection or conflict feels more comfortable.
To help overcome the emotional side and look at it rationally, let me share an example. Let’s assume a business has the following:
Revenue $ 5,000,000
COGS $ 2,750,000 (55%)
Gross Profit $ 2,250,000 (45%)
OpEx $ 1,500,000 (30%)
Net Income $ 750,000 (15%)
Now let’s assume that you decide to raise prices by 3%. All other costs stay the same. Now the numbers look like this:
Revenue $ 5,150,000
COGS $ 2,750,000 (53.4%)
Gross Profit $ 2,400,000 (46.6%)
OpEx $ 1,500,000 (29%)
Net Income $ 900,000 (17.5%)
Maybe that doesn’t sound like a significant increase. It’s only a few percentage points. Well, look at it a different way:
• You just increased profits by $150,000
• That is a 20% increase in profits from a 3% increase in prices
• Assuming that your company’s valuation is 5x EBITDA, your business is now worth $4.5MM vs $3.75MM prior to the change – a $750,000 increase from a small 3% increase in prices!!
Pricing changes are not easy. And they should not be taken lightly. But such changes are one great example of how little adjustments can make a big impact on your company!
For more thoughts around pricing or to discuss specific scenarios, please feel free to contact me at firstname.lastname@example.org