Firstly, let me start by saying I haven’t gone out of my mind!
When businesses come up against the problems of a global recession, there are generally only three ways identified to cope.
1. Sell more product or,
2. Reduce costs, or
3. Offer discounts.
More-often, the ‘Reduce Costs’ option is chosen alongside ‘Offer Discounts’ as a way to help the company survive.
Whilst reducing cost will always be beneficial to any company, after all, no-one like wastefulness… offering discounts as a way of protecting the company is an absolute disaster.
I will try to demonstrate why, using simple maths.
Let’s assume that during non-recessional times our company has a turnover of £1000, and that from that turnover, £500 is taken as variable costs associated with production and £400 is taken in fixed costs. This leaves us with a profit of £100.
Now a recession starts to bite into our business empire and as-is usual, sales take a 10% drop. Now our figures show turnover £900 (10% market contraction), variable costs £450 (10% reduction in-line with reduced sales), our fixed costs remain at £400.
You can see that our profit has now been reduced to £50. That’s a 50% reduction in profits.
At the next Board/Management meeting it is decided that to try to increase sales, a 10% discount should be offered as an incentive.
Due to the discount plan our turnover has now reduced by 10% to £810. The variable costs remain the same as the production levels have not decreased, at £450. Our fixed costs are still £400. The difference now, is that our imaginary company is now making a loss of £40!
Suddenly, the discount option doesn’t seem so good does it?
Now let’s look at the same company, but this time, we’ll use a much better strategy. I’m sure you’d agree that it wouldn’t be beyond the realms of possibility to get the sales team to make a few more calls and increase sales by 1%. Also, it should be possible to save 1% on the variable costs by reducing wastage, etc. Then if we increase our prices by 1%, we get the following figures….
Turnover, with the 1% increase in sales is now £1010, Variable costs are now £505 (1% increase in line with additional sales), our fixed costs are still £400, meaning our profit with sales increase alone is £105.
Now if we add in the cost savings, our variable costs are reduced by 1%, giving £499.95 (call it £500), giving a profit of £110.
If we now add our 1% price increase to the equation, our turnover is now £1021, our variable costs are still £500, our fixed costs are still £400, but our profit is now £121. That is a 21% increase in profits, from a 3% change in practical terms.
And that my friends, is why making these changes is the only safe why to ensure the future of your Company in a recession!
Now, I realise that many people will be shouting “I can’t put my prices up, I’m struggling to keep customers with my current pricing structure!”
I understand that on the face of it, this seems difficult, especially in the current economic climate, but there are many ways to increase your prices without actually increasing your prices.
Most industries add non-chargeable ‘extras’ to their products… on airlines it could be exit, or bulkhead seating where there’s extra legroom, in stores it could be free delivery on items. With this example, maybe you could introduce a cost difference according to distance, or time of day, or next-day delivery. I’m sure if you use your imagination there are several ways of achieving a 1% increase.
If your customer decides not to take you up on your offer of ‘extras’ all you’ve done is save yourself the additional costs involved with doing it for nothing. WIN-WIN!!
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