What Happens When You Lower Your Prices?

While it may seem obvious enough that you should always strive to realize the highest possible price for your products, a closer look at the problem quickly shows why it’s absolutely critical to your company and to you as a salesperson.

Economics: In many industries, price discounts of 15-20% are common in order to win business, so a difference in just 1% of the selling price does not seem to be that important. However, let’s take a look at the effect this trivial difference can have on the company’s bottom line. As an example, suppose a company has a net profit before tax of 5% of sales. A 1% difference in the selling price will have a 20% impact on profits!

Let’s apply this analysis to your own company.

1. What is your net profit before tax, as a percentage of revenues?

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2. Divide that number into 100:

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3. That is the multiplier impact that a discount of 1% has on your firm’s profits.

In case you don’t like doing simple math, net profits of 10% means that every percentage of price discount is multiplied ten times. Net profits of 20% means that every percentage is multiplied five times, and so on.

If you follow the logic, then it would seem that companies that regularly discount 15-20% would never make money. The reason that’s not the case is that those discounts are already factored into their profit structure.  In that case, you can use the calculations above to see what the positive effect is of getting a premium.

The good news is that in that case, being able to justify a 1% price premium will make a 20% impact to the bottom line.

Besides this immediate, leveraged impact that a price cut has on profitability, proper pricing is also essential for any salesperson looking beyond just this quarter’s quota. A price cut may help close business today, but it only makes future sales even harder, because of the effect it has on your buyer’s behavior:

Reinforcement: It is human nature that behavior which is rewarded is reinforced and repeated. When your buyers ask for price discounts and you oblige, you are reinforcing an escalating series of future discount requests in the future.

Signaling: Secondly, think carefully about the signal that price sends to your customers. In products that are difficult to evaluate before purchasing, prince is one of the most significant cues to the quality. When you lower your prices, what signals are you sending about the quality you offer and your confidence in it?

Trust: Backing off your price demanded at the late stages of the sales cycle may contradict everything you had previously said to the buyer during the sales process. They will not trust your words in future sales.

Relationship: Customers who switch to you because of price will leave because of price. The length of the relationship will be taken out of your control.

In a previous article, If It Was Easy, Anyone Could Do It, we focused on how doing the hard work to justify a higher price can actually make your customer better off. As you can see from following the math, it has a huge impact on your own company as well.