Pricing matters. A lot. In the '90s, McKinsey & Co. published a study in the Harvard Business Review on the drivers of profitability. They studied 2,600 companies in different industries with different economics and found some interesting things: On average, a 1% improvement in volume increased operating profits by 3.3%. While a 1% improvement in price, increased operating profits by 11.1%.
What this is saying is that improvements in price typically have 3-4 times the effect on profitability as proportionate increases in volume. Why might this be?
When you sell more of something you have more revenue, but you also have more cost. You have to make that additional widget and there’s a cost in materials and labor. Or if you’re in a service business, you have the cost of the person doing the job, either yourself or one of your employees. Not every extra dollar you bring in will fall to the bottom line.
When you bring in additional revenues through higher prices, all of that usually does fall to the bottom line. Some companies in the McKinsey study were able to increase profits by 35% with just a modest 3% increase in price. But it’s knowing how to increase the price that’s important.
Now, the reverse also holds true. A 1% decrease in price, would destroy 11.1% of a company’s operating profits. So, with such extreme profit leverage, pricing is something a company can always improve, and should strive to improve.
