Price Revisited

Few business owners realize the powerful leverage that lower prices can have on their profits. To get a feel for it, consider this hypothetical example.

You own a bowling center and you normally sell bowling at $3 per game and shoe rentals for $3.00 per pair. On a transaction of two games and shoe rentals, your revenue is $9.00 per game.

After calculating your fixed costs and variable costs, you estimate that your costs per game are about $1.00 per game and shoe rentals about $1.00 each. On this transaction, you make $6.00 for a 67 percent gross margin.

After keeping prices at this level for five years, you raise the price to $3.60 per game. That’s a 20 percent increase — not small. But it’s nothing compared to the effect on your profits. Say 200 people buy the $9 package each week. At $10.80, 20% less games are bowled. But even at 20% less, the business makes 3% more profits. Details:

Price Transactions Revenues Costs Profits
$9.00 200 $1,800 $600 $1,200
$10.80 160 $1,728 $480 $1,248

What happens when you cut prices? Say you drop it by $1 or 11 percent. At $8, you sell 20 percent more games. Revenues climb about 9% or $136. Costs per game stay the same, so total costs increase 25 percent. You make almost 3% less money for working harder. Details:

Price Transactions Revenues Costs Profits
$9.00 160 $1440 $480 $960
$8.00 192 $1536 $600 $936

When does cutting prices dramatically increase profits? The answer may surprise you. If you cut prices about 10 percent, you have to have 18 percent more transactions to make more money. At $8, you’d have to do 188 transactions to beat the $960 profit you got from 160 transactions at $9 each. Your extra profit comes to $1. Details:

Price Transactions Revenues Costs Profits
$9.00 160 $1440 $480 $960
$8.00 188 $1504 $543 $961

On the other hand, if you raise prices 25 percent you’d have to lose almost one out of three customers before it hurt profits at all. Details:

Price Transactions Revenues Costs Profits
9.00 160 $1440 $480 $960
$12.50 115 $1440 $690 $950

If you’re cutting prices without having a strategy to sell more ancillary products you’re going to need a lot more new customers than you might have suspected to avoid losing money. Just driving traffic in the hopes of selling more food and beverage is not a strategy.

But driving traffic with a clear goal to sell more food and beverage is a very viable strategy.