Durham University Business School did some research in 2004 that I think is relevant today in our current different market conditions. It concerned the possible responses to falling sales, and charts the effect on your profits of different amounts of price reduction or increase.

Price Reduction Chart

The first chart shows how much your sales have to increase to compensate for any reduction in your prices. And it shows that the impact of price reductions can be substantial. For example, if you have an initial gross profit of 10% then a 2% price drop must attract a 25% increase in sales in order to maintain your profit level; while a 5% drop requires a whopping doubling of sales to finance it.  

Price Increase Chart

On the other hand, the second chart shows the drop in sales that your business can tolerate in response to a price increase. Here the figures look better: with the same initial gross profit of 10%, if you increase your prices by 2% you’ll be better off until your sales drop by 17%; and a 5% increase means you can afford for sales to reduce by a third and still be no worse off.
So the results show that it could be better for your business to increase your prices if your figures are falling.

The important point to emphasise is that we are talking here about actual money, not just percentages. The figures apply whether you’re talking about sales of £100 or £1,000,000. Raise your prices by 10%, sell only half as many items at the new price, and you’ll bank the same amount of money.

The information highlights two often-overlooked facts: firstly, that you really need to know your gross profit margin pretty accurately at all times (without this key piece of information you can’t even start working out where you stand); and secondly, that the name of the game in business is profit rather than turnover.

These two charts show the benefit of high-margin businesses. A glance at the price reduction chart confirms that the higher your gross profit, the greater the positive effect of reducing prices; while the price increase chart clearly shows that low-margin businesses have the most to gain by increasing their prices.  

The moral of the story

if you aren’t happy with the performance of your business, actively consider price increases. Make sure you do these calculations before, of course, and you’ll know of any other factors that are particularly relevant to your own business which may impact on this formula. But if you get your sums right, you could transform your business, and your lifestyle, by increasing you prices rather than reducing them.