Most business owners put off raising their prices because they are worried that some of their customers will leave. In this post, I show how your business can still be more profitable in that scenario, and discuss the other beneficial side effects.
First, the other beneficial side effects
Before we get into the simple math about how your profit will change, I want to talk about the other benefits.
If you lose customers, that means less inventory to manage and/or less work for you and your team. So not only could you be more profitable, but you would have to hold less inventory OR you could cut down working hours for you and/or your team OR your team could have extra capacity for new, more profitable clients.
Important note: the calculations below only cover the gross profit, so they don’t reflect how you could lower your overheads (e.g. customer service team) with less customers. So it is possible to lose even more customers than the table and formula below and still be profitable. However, higher prices may require more marketing expense. I like being conservative, so I will say “profitable” through the rest of the post even though “gross profitable” is a more accurate term.
An example of the concept
Imagine you have monthly revenue of $20,000.
You double your prices. Now your monthly revenue will be $40,000.
Except! Half your customers leave. That’s a huge number, the stuff of nightmares. Now your monthly revenue will be $20,000.
Ouch! You’ve been on an emotional rollercoaster and revenue hasn’t changed from the starting point.
However! While that’s true, we haven’t looked at the change to your costs.
You have the same revenue, but half your costs because half your customers fled your price rise.
Same revenue and less costs = more profit.
Half your customers left, and you are more profitable than before. Plus there’s all the other beneficial side effects mentioned in the previous section.
Emotional rollercoaster was worth it now, right?
That’s a simple example and may be all you need to dispel the fear of increasing your prices.
However, if you want to know the exact percentage of customers your business can afford to lose with the price rise you have in mind, we’ll need to do a few simple calculations.
A number you’ll need before we start
You’ll need your gross profit margin as a percentage of revenue.
That’s an awfully long, jargon-filled name, so let’s abbreviate it to GPM.
You don’t need to understand what it means for now (read this later for the jargon-free important bits). Here’s the simple calculation:
GPM = (sales less the cost to provide your product or service (excluding overheads)) divided by sales.
So if you have $20k a month in sales, and it costs you $10k for your team to do the service (or manufacture and ship the product) that your client paid for, the equation looks like this:
GPM = ($20k – $10k) / $20k = 0.5 = 50%
Estimating if the change could be profitable
There are two key pieces of information you need:
- The price increase, as a percentage.
- Your gross profit margin as a percentage (GPM), from the previous section.
In the table below, select your price rise column and your GPM row, then where the two intersect is the percentage of customers you can lose and still be as profitable as before the price rise:
An example, with workings
Lets use the example of Alex who wants to raise prices, but is afraid that customers will leave.
Here’s the GPM calculation: ($20k sales – $10k costs ) / $20k = 0.5 = 50% GPM.
Price rise: $1,000 fee becomes $1,500 = 50% price increase.
In the table above, the 50% row and 50% column meet up at -50%. This means that Alex’ business can lose 50% its customers, and still be as profitable as before the price rise.
Optional: Don’t believe it? Take a look at the formula
Warning: the calculations get a little less simple in this section. Skip to the next section unless you really need some more proof.
Here’s the formula, where again negative numbers are the percentage of customers you can lose and still be as profitable as before the price rise:
Maximum customer loss % to stay as profitable = GPM / (GPM + Price Rise %) – 1
Still doesn’t seem possible? Here’s another way to step through it:
- Start with a random sales amount and multiply it by GPM to get the gross profit amount, e.g. $100 sales x 20% GPM = $20 gross profit.
- Do the price increase step, e.g. 15% price rise = sales $115 and $35 gross profit. The extra $15 of price rise is added straight on to gross profit, because there is no additional cost.
- Do the ‘lose customers’ step on both figures, e.g. -43% loss = sales $65.55 and $19.95 gross profit.
- Account for rounding error and that’s the same gross profit as before the price rise (step 1).
You can see the surprising amount of customers you can afford to lose, despite how counter-intuitive the concept feels. For example, doubling your prices (the 100% column) on the lowest margin (5%) means you can lose at least 95% of your customers and be as profitable!
Important takeaway: low margins mean that doubling your prices is an obvious, probably-low-risk strategy to consider.
You might be happy to lose even more customers and have your profit drop a little, for example if you want a simpler, smaller business.
Tips for raising prices
Despite how positive the outcomes above can be, don’t raise the prices for all of your customers at once. Test it on a few and see how many of them say that they’ll leave.
Test it privately so that you can reverse the price rise if it’s a big problem for your test clients.
Test it on your lowest-quality customers, so you’re less upset if they leave.
If you’re still worried about driving away customers, add some extra value along with the price rise. Make sure that the extra value costs less than the increase in price, and your profits will increase.
If you’re thinking about dropping your prices to increase the numbers of customers, most often my response is: don’t, unless you have really high margins. Otherwise you have to do crazy things like tripling the number of customers to make the strategy work.
Want to see how this could work for your business? Let’s have a chat.