MSP Answers

MSP Answers

30.6.2012 Article 35


Price to the market

I went to my local butcher last week to buy two of his famous ‘family pies’. These are just like a good old-fashioned Aussie meat pie – but big enough to feed a small family. We have a medium-sized family so I needed two. I was being a very good husband – my wife had asked me to pick up the pies during my travels so I was simply doing what I was told. I was therefore devastated when I asked for a couple of pies and was told that they had sold out. I couldn’t believe it – my life flashed before my eyes. How would I cope when I arrived home to tell my wife I couldn’t deliver on her simple request for the day? The car was full of petrol – maybe I could just start driving and I might make it to the next state before she realised I wasn’t at home with her pies.

I took a slightly more rational approach. Maybe there was a sensible explanation as to why the pies were all gone by lunchtime and I could somehow explain it to my wife. I asked what had happened today that was so unusual. “Nothing unusual about today – we seem to be selling out earlier each day. They seem to be really popular,” I was told matter-of-factly. I told him he should put his prices up or make more. “Our customers tell us they like the fact they are only $15 so we wouldn’t dare put the price up or we might lose a few sales and staff are too hard to get so I can’t make any more.” He had all the solutions – but I still didn’t have my pies.

While still in panic-stricken fear, I was busy analysing the flaws in his business model. He has a product that he sells out of by lunchtime each day that he can’t make more of and he doesn’t want to charge more for.

If I accept for the moment that he may have trouble finding skilled staff and he isn’t sure if the family pies are only popular at the moment because it is winter, then the obvious solution to me is to put the prices up. I subtly suggested that he should consider the possibility of revising his pricing model with a statement along the lines of, “You should put your prices up!” Firstly he thought this was crazy for a customer to be asking to be charged more and secondly he was incredibly worried he would lose clients. I explained the logic further.

At the moment he is losing clients (me) from lack of stock. He can’t make more pies therefore he should put his prices up. Some clients may choose not to purchase the pies but if he incrementally increases his prices to test the market sensitivity then he will arrive at the optimum price/sales ratio. I had to remind him that selling out for the day by lunchtime or by 5.30pm made no difference to the sales volume for the day so if an increase in price meant that the pies sold out later in the day then that was entirely acceptable. I even ran some numbers for him. At $15 per pie, his cost of production was about $12. He worked on a 20 per cent GP and made $3 per pie. He produced 100 pies for the day so his GP from the pie sales was $300. He was quite happy with that. No matter what he sold the pies for, his cost of production was the same. I asked what would happen to his sales if he put his price up by $1 per pie. At $16, he was of the opinion that sales would probably stay the same. That was therefore an easy decision to make – although it didn’t help extend the pie supply to later in the day (I was ultimately after that). With just a $1 increase, his GP percentage goes up to 25 per cent and his profit for the day jumps to $400 – a 33 per cent increase. I suggested he try putting the prices up to $16 tomorrow and test the reaction. With a few incremental steps, I didn’t think $18 was out of the question. At $18, the numbers looked dramatically different. The GP would then be 33 per cent but his profit jumps to $600. That is a 100 per cent increase in profit for the day. Remember that there is no increase in cost of goods sold. He could keep increasing prices until he arrived at a figure that saw his sales extended until late afternoon – or he could simply be happy with doubling his daily gross profit figure from the pies. For this small piece of advice I only asked that he quickly make me two pies!

In your business, don’t be scared to put your prices up. If you are incredibly busy and can’t get enough staff to deliver your services, maybe you are not charging enough. Small incremental increases help you to test the market to see what the market will bear. Ultimately, you want to be just under the maximum the market will bear.

Tell me if I should have just started driving rather than arrive home empty-handed at  md@smallbusinessrules.com.