Purchasing Power: Part 2 – Pricing

This is the second post in a series about the power of the buyer. In the last post we established a basic, yet very important, tenet of purchasing: The easiest way to increase profitability is through the buyer by cutting costs. Now that we have cut the cost on the table and chair set we are selling, we have to figure out the best way to price it.

Pricing is a really difficult thing to figure out because there are so many variables that affect how you price something. But before we get into those, lets go back and cover some basic economics…and more specifically…a demand curve. As you can see by my awesome (and colorful!) drawing of a demand curve…as price decreases the demand for the item increases…translating into more sales. This is economic theory, but it has proven to be pretty accurate over time for the most part.

OK…now that we got that out of the way…lets talk about how to price our table and chairs. We basically have three options, so lets take a look at the pros and cons of each of them Our three options are:

1. Lower our selling price relative to our costs
2. Leave the selling price where it is.
3. Lower our selling price at a different factor

Lower Cost by the same percentage

In our example from the first post our cost was $15 and our selling price was $30 for a nice $15 profit, with a 50% profit margin. Then we cut our cost down to $12, a 20% savings. Lowering the selling price by the same percentage to $24 would yield a $12 profit, with the same 50% profit margin. So the profit margin remains the same…but we are getting $3 less than we were before. That’s bad! But wait…remember our demand curve from above (refer to super awesome picture)? If you lower your selling price you will sell more of them. Theoretically, your 20% lower selling price will draw more customers to at least make up the difference. This is an excellent strategy for items where there is a lot of competition around your price level. Cutting prices lower and lower will almost certainly increase the quantities sold. But what if your business isn’t exactly commodity like?

Leave Selling Price As Is

Using the same example as above, we cut our costs by 20% to $12. But this time sell it for the same $30. This yields an $18 profit, with a 60% profit margin! Alright! Both numbers are higher! Our demand stays constant and we pick up an extra $3 per set. This is the easiest way to increase profitability as a buyer. It requires nothing except for negotiating/sourcing a lower cost. The sales don’t have to increase to pick up extra profit. This is an especially good strategy if you have limited production and don’t have the capacity to sell more quantity.

Lower Selling Price By Smaller Factor

This is my personal favorite method. Basically you split the difference between the two strategies listed above. We take the same 20%, but this time sell it for $27.50. This yields a $15.50 profit, with a 57.3% profit margin. Both numbers increase from the original deal, which is good. The added bonus for doing it this way, is that because you have lowered your selling price…more new customers will be likely to buy your product. You also get to show your customers that you are working hard behind the scenes to save them money…and everybody likes that!

I suppose there is another option, which is to RAISE your price after cutting costs. But I think that’s foolish and can backfire on you quickly if word gets out.

These pricing strategies are very effective for general product sales. If you deal with highly specialized/luxury items, the pricing structure changes completely. But that’s a topic for another day.

What pricing strategies do YOU use? Let us know in the comments!

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Tagged as: Pricing, Purchasing