Power of Pricing
Prices are extremely important because it has a powerful impact on a company’s bottom line. Every cent higher price is also a cent higher operating income. Marn, Roegener and Zawada analyzed the 1200 largest, publicly held companies from around the world. The picture below shows their average income statement of these companies (revenue, fixed cost, variable cost and operating profit). By modeling the impact from a percentage improvement in each of these factors price is the single factor with highest effect on bottom line.
1 percent improvement in Price with volumes fixed generates 1 percent higher revenue. Costs are the same, fixed cost by definition is not changed and variable cost is also constant as volumes have not changed. This means that the operating income increases with the same percentage point as the revenue. When modeling the same 1 percent improvement in variable costs, fixed cost, and volume the same leverage I not achieved. Variable cost is, with a 7.3 percent effect on operating income, the closest rival.
Prices is the most powerful profit lever that a company can influence, very small improvements in price can mean huge increases in operating income.
The reasoning is based on unchanged volumes when doing a price change but that may not be reasonable so based on the same data. What kind of volume change is necessary to offset the profit improvement from a 1 percent price increase? Based on the Global 1200 a 5% price decrease would require a 17.5 percent volume increase to break even. For a 5 percent drop on process to generate a 17.5 percent volume rise would require a price elasticity of -3.5:1. That is, every percentage point drop in price would have to drive unit volume up by 3.5 percent. According to Marn, Roegener and Zawada real markets show price elasticity’s commonly reach a maximum of only -1.7:1 or 1.8:1 and on rare occasions, usually for consumer items purchased on impulse, it may be as high as -2.5:1.
1 percent improvement in Price with volumes fixed generates 1 percent higher revenue. Costs are the same, fixed cost by definition is not changed and variable cost is also constant as volumes have not changed. This means that the operating income increases with the same percentage point as the revenue. When modeling the same 1 percent improvement in variable costs, fixed cost, and volume the same leverage I not achieved. Variable cost is, with a 7.3 percent effect on operating income, the closest rival.
Prices is the most powerful profit lever that a company can influence, very small improvements in price can mean huge increases in operating income.
The reasoning is based on unchanged volumes when doing a price change but that may not be reasonable so based on the same data. What kind of volume change is necessary to offset the profit improvement from a 1 percent price increase? Based on the Global 1200 a 5% price decrease would require a 17.5 percent volume increase to break even. For a 5 percent drop on process to generate a 17.5 percent volume rise would require a price elasticity of -3.5:1. That is, every percentage point drop in price would have to drive unit volume up by 3.5 percent. According to Marn, Roegener and Zawada real markets show price elasticity’s commonly reach a maximum of only -1.7:1 or 1.8:1 and on rare occasions, usually for consumer items purchased on impulse, it may be as high as -2.5:1.
