Myth: small price variations have negligible impact on profits

Dear Friends,

most business managers are under the impression that small price increases have no positive impact on profits. Nothing could be more wrong. We will deep dive this below.

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Myth: small price variations have negligible impact on profits

Most business managers are under the impression that small price increases have no positive impact on profits. Nothing could be more wrong.

An improvement by 1% of net sale prices – that is a price increment by 1% or a reduction by 1% of the discount, increases profitability even by 10% or more. I will illustrate this with an example.

A company with a 10% operating profit margin would improve this to 11% simply by raising prices – i.e. increasing list prices or reducing discounts. In companies with lower operating profit margins the impact of price variation on profitability is even more pronounced. Take the case of Volkswagen, whose operating profit margin from the 2021 sales was 7.6%: by increasing sales prices by 1% it would increase its profitability by 13.1%

This goes to show that small price increases generate a significant effect.

One of our clients – a manufacturer of chewing gums – was astonished to discover the difference a few cents can make. A typical packet of chewing gum is priced at 90c. The results of market research that we conducted for one of our pricing projects revealed that 1€ was an important price threshold – which meant that we could increase the price of the chewing gum to 99c without risking perceptible losses in terms of volumes, and that the risk would present itself only if the 1€ threshold was crossed.

Our predictions were confirmed, the volume of sales remained stable, and the additional 9c, multiplied by the very high number of items sold, brought in a higher revenue – which was in fact net profit, because our costs had remained the same.

In addition there was no harm in terms of price image, as the new price was still below the price threshold.

If we applied the same logic to discounts, we would realise how small improvements make a big difference.

The CEO of a known multinational involved me in a pricing project in an attempt to increase the company’s profitability, which had been lower than anticipated. We started by looking at their discount policies.

We noticed that their discounts were offered in multiples of 5: 15%, 10%, 5% (could it be because subconsciously we associate the number 5 to love, health, empathy?). We sought an explanation from the sales team. “Well, you know, when a client asks for a discount I start off with 5%, then advance to 10%, and eventually I offer another 10%, just to close the deal”, was what we heard. The team acted in good faith, confident that what they were doing was to the company’s advantage: they were closing a deal after all. But if even for George Orwell 2 and 2 can give 5 (as we read in the wonderful 1984, which incidentally Orwell wrote in 1948…), it was obvious that the sales team had forgotten that other numbers exist beyond 5 and its multiples, say 1, or 2, or 3; but even 6 or 7, or 8. But joking aside, sometimes habit trumps common sense.

The CEO and I organised training sessions on selling value, for the entire sales team. In one of the modules, we discussed how to manage the discounts – starting off from 5% and offering further decreasing increments, for example an additional 3% and a final 2% - in any case avoiding multiples of 5!

We did not want the sales team to feel that we were blaming them, nor did we want to completely revolutionise their sales practices, and these easily applicable adjustments made an enormous difference to the profitability of the company.

When prices are set, they must be optimised. When haggling begins, discounts must be kept to a minimum. You are working on perception; you are selling the value of a product or service.? What is at stake is not simply the name, but the appeal of the company – what the French would call allure.

What is your view on this myth? Any other cases or examples to quote?

Interested in learning more about pricing myths? You will find pricing insights in the book The 10 Rules of Highly Effective Pricing.

‘The numerous case studies and industry examples make The 10 Rules of Highly Effective Pricing a very valuable guide to a state of the art pricing’.

Markus Mildner CEO Siemens eMobility

Get your copy of ‘The 10 Rules of Highly Effective Pricing’ here.

Get your copy of ‘The Pricing Model Revolution’ here.

You are most welcome to share your views, feedbacks and own pricing experiences. Thanks a lot for your interest and support!

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