At a very basic level, people use pricing strategies to assign market prices to their products and services. Your standard academic style standard trading education will expose you to pricing strategies like market penetration, premium pricing, skimming, bundle pricing, etc. These topics are not mind blowing, but their conceptual importance runs deep in business.

Two things that small businesses often overlook when setting prices are the price elasticity of their products and the competitive position of their products in the marketplace. Small oversights in pricing can lead to a significant unnecessary loss of profitability.

Here is an example:

Consider a fictional family business, Edith’s Bakery (EB), which sells an average of 600 bakery items to public/corporate buyers per day at an average of $10/dozen or $0.83/unit. EB is only open 6-7 hours a day until they sell out, and they’re only closed on 10 federal holidays. That’s $177,500/year in revenue.

Now let’s say the price of a single unit is $0.94 with your volume sales discounts also priced proportionately with your competition. This is below the price per unit at both chain stores Dunkin’ Donuts and a more well-known Minnesota bakery located in Cold Spring, both priced at $0.99 per unit (rough estimate based on those companies’ websites) . If these two companies are EB’s main competitors and EB’s pricing plan is to undercut their competition in order to be competitive, they are probably throwing money away.

Why?

EB is $0.05/unit below nearby competitors, more than 5% less than the competition.

Food products tend to have inelastic demand, so you shouldn’t expect the volume purchased to go down much if prices increase slightly.

Your loyal customers are unlikely to leave if you stay below the competition’s prices. Price-sensitive consumers are also unlikely to leave, as long as they don’t raise prices by more than $0.03-$0.04.

So how does all this work?

If EB increased their price/unit by $0.03 in addition to proportionally increasing all their volume discount deals, they now earn an additional $6,390/year. That’s a 3.6% increase in revenue/year! However, they would still be below their competition by more than 2% in price.

Unless there is a very slight increase in hours worked (if their demand decreases), they do not have significant additional expenses. A significant portion, if not all of the $6,390, will be written off directly on your profit and loss sheet as gross profit.

If EB has a 50% gross margin, it would have grossed $88,750. When $5,000 of the aforementioned $6,390 is added directly as gross profit, they simply increased their gross margin by about 5.6%. That’s the approximate difference in reported gross margin between Walmart and Target each year.

Pricing analysis is one of the most important tools that is overlooked or missing in many businesses, but especially in small businesses that don’t have the resources to do it. Don’t let your organization fall victim to this.