Third Way to Increase Profits

A while back, I wrote a couple of articles about how to boost profits. The first was to control your costs. You can find that article here. The second was to increase your price. That article can be found here.

There is yet another way to increase your profits and that, ironically, is to lower your price. This particular strategy is very well suited for higher volume items.

Let’s look at an example.

NOTE: In this hypothetical example, all of these numbers are totally made up. I’m choosing a donut example because I had some amazing mini-donuts at a market this morning.

It’s Time To Make The Donuts!

For example, lets say that you make mini donuts. You have a booth setup where you can go from market to market relatively easily. You currently sell a dozen donuts with chocolate sauce and sprinkles for $10. The cost of making each dozen is $1. On average, you sell 50 dozen per day on market days. Your market days are Friday, Saturday and Sunday. That means that you sell 600 (3 days per week x 4 weeks per month x 50 dozen per day) dozen donuts per month.  Your revenue is $6000 ($10 x 600 dozen donuts) per month.

Subtracting the cost per each dozen donuts ($1/dozen), you make $9 per dozen, or $5,400 per month right? Not quite. We still have to subtract operating costs.

Operating costs are those costs that you must pay to run your business. Example costs are salaries, storage, booth rental, equipment rental or amortization, transportation, etc.

In this case, your main costs include:

Monthly Operating Costs

    Salaries – $10/hour x 10 hrs/day x 12 days/month = $1200

    Storage – $150/month

    Booth Rental – $250/show x 4 shows/month = $1000

    Equipment Amortization/month = $400

    Transportation (fixed cost – truck payment) = $560

    Transportation (variable cost – tolls and fuel) = $240

Total Monthly Operating Costs: $3550

With these costs in mind, your total net profit would be $1850 ($6000 gross revenue – $600 costs for donuts – $3550 operating costs).

While you may want to increase you profit, your first instinct is to charge more per dozen donuts. However, you may already be running into some resistance from customers at $10. Raising the price will probably mean that you will sell less donuts, thus lowering your monthly net profit of $1850.

Another way to increase your monthly profit is by lowering the price. This means that you will make less per dozen donuts sold, but this will be offset by a non-linear increase in donut sales.

Suppose you begin to sell your donuts at $7 per dozen and all other expenses remain the same.

At a lower price point, your customers begin to buy more donuts. In fact, you not only get more donuts, but they buy more than a dozen at a time. You suddenly find that you are doubling your sales and selling 100 dozen donuts at each show!

Your monthly net revenue suddenly goes to $8400 (3 days per week x 4 weeks per month x 100 dozen per day x $7 per dozen), an increase in net revenue of $2400! If all other costs remain the same, your monthly net profit jumps to $2850 ($8400 gross revenue – $1200 costs for donuts – $3550 operating costs)!

Another benefit of this is that, due to increased sales, you may be able to take advantage of the economy of scale by purchasing the donut ingredients in larger quantities, thus getting a quantity discount. This lowers the cost of making each donut.

Before you adopt this and lower all your prices, you should evaluate whether or not your products are a good candidate. This technique is appropriate for high-volume items with lower costs of production. You also want to make sure that you consider the value of your items. If you are catering to a high-end demographic then they may see your lower cost item as having little value and pass it up.

How To Know If You Should Lower Prices

  • You have a lot of excess inventory at the end of the show
  • You overhear customers comments such as “we can share some donuts”
  • People walk off when they learn the price
  • You are becoming more efficient at creating the product and can get more finished in less time

How To Know If Lowering Prices Is Not For You

  • You get really long lines waiting to make a purchase
  • You regularly sell out of an item
  • Lowering prices means that you are selling them for less than the cost of production
  • People begin to think that your products are “too cheap” and have little perceived value

As always, market conditions are fluid and you should evaluate your specific situation to determine whether or not this is right for you.

See you at market!

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