I was reading a fantastic article on Deadspin Regressing this morning by Andy Schwarz about the woes currently beguiling University Michigan football. In case you’re not a football fan… 1) bear with me, I’ll get to the point and 2) Big Blue has been having some problems lately. Namely, they are terrible. The team is bad, they have a 100,000 seat stadium with umpteen years of sold-out games, and right now they are really struggling to fill seats. While some bemoan the commercialism rampant in college sports (because, well, there is a lot of it), Schwarz does a great job or laying out how Michigan has a pricing problem.
This gets us to the heart of the matter. This past month we had a client who’s business was doing pretty well but revenues have stagnated. Interestingly the owner made the comment “Things are great, but I just can’t ship enough product.” The company thought they priced their product well as compared to competitors and are perceived well in the market. So what gives?
Just like Michigan, the issue is that you have a pricing problem. How so?
Let’s assume that the fullfilment problem can’t be solved simply by adding more capacity. In the case of our client there’s significant lead time involved in adding supply capacity. What is the business to do? Raise prices. And the ideal price is likely just before unit sales start to dip and inventory increases. Why? Because that is the point at which you are likely maximizing profit AND delivering what your clients perceive as value for money.
Running the Numbers
And let’s drill down on that profit comment for a moment. If you are already selling every unit (hour / widget / whatever) possible, why raise prices? Because you are now in the goldilocks zone. Look at the chart below. Our client had a gross profit margin of approximately 60%, and no material increase in SG&A (a/k/a operating) expenses associated with increased sales.
Now let’s harken back to those days sitting in Econ 101. Let’s drop a “Demand Curve” on top of our pricing chart. Clearly there is a point where further increases in pricing will not result in increasing profits since demand begins to wane.
Tying Back to Business Valuation
We talk time and again about how earnings drive value. Whether you are Michigan Football (also a business. But don’t just take our word for it) or our client’s widget business, maximizing profit is the clearest way to increase value. And the numbers can be significant. With our client we were able to calculate that if the business where able to increase and sustain pricing by 25% (while holding margins), the impact on value would likely be a high 6 figure number. Not a bad haul for breakout out some new price tags.