In Part One (Increasing Pricing: “The Rational Argument”) of this pricing discussion, I talked about the cash flow impact of raising prices. We discussed the emotional struggles of making this change and the fear that customers will leave because of the price increase. That is an understandable fear, so let’s look at how that would impact your business. The question we want to answer is; how many customers would need to leave to cause your profitability to decline?
Let’s assume these current financials for your business:
Revenue $ 1,000,000
COGS $ 700,000 (70%)
Gross Profit $ 300,000 (30%)
OpEx $ 250,000 (25%)
Net Income $ 50,000 (5%)
You decide to raise prices by 5% which results in some customer attrition. What percent of your current customers could you lose without reducing your Gross Profit or Net Income?
Here are the revised financials after factoring in both the price increase and customer attrition:
*Note: Gross Profit and Net Income do not change
Revenue $ 900,000
COGS $ 600,000 (66.7%)
Gross Profit $ 300,000 (33.3%)
OpEx $ 250,000 (27.8%)
Net Income $ 50,000 (5.6%)
The answer is 14.29%.
In summary, you can actually lose almost 15% of your customers and still have the exact same profitability from a small increase in prices. Obviously no one wants to lose customers, but here is another way to think of it. You could be replacing your customers that value you least (and wanted to pay you less) with a new group of customers that truly value your expertise. Doesn’t that feel good (even before the extra profits)? You also have to do 25% less work to reap the same rewards. You might even take a vacation for a day or two!
I’ll share a personal experience. At a software company that I was managing, we had numerous technical issues and our customer Net Promoter Scores were declining every six months. We were under investing in the product, since we weren’t making money. Thus, every time the idea of increasing prices came up we tabled the idea until we finally were out of options. We sent letters and emails to all clients notifying them that pricing was increasing by 5%, but also that we had not raised prices in five years, and we were committed to increasing our investment in the software moving forward. We expected a decent backlash and prepared our Account Managers for the worst. In the end, we lost 3 clients. Out of over 3,000. Or 0.01%.
I’ve actually been involved in a few of these scenarios, and the results are eerily similar. If you do it right, communicate like crazy and aren’t greedy then the results will improve both your business and your customers.
If you are interested in discussing ideas and options around pricing, please contact firstname.lastname@example.org.