The Argument about Volume:
Many, many businesses drop their prices on the assumption that more sales will be generated by it.
Anyone who has ever been exposed to basic economic theory will have heard about supply and demand.
In short, the theory goes that if you drop your prices, consumers will buy more. This almost never happens in real life. At least, not in a way that is sustainable.
What happens in real life is that one business drops its prices. Because of it, it may increase its volume for a short time before competitors become aware that they are losing market share to the cheaper supplier.
So the competitors drop their prices too, even undercutting the original cheaper supplier, to take the business back.
Before long, only the strongest competitor will survive the price war that eventuates. Once there is no competition left, the prices shoot right back up again.
How to Calculate the Gross Profit Margin.
The gross profit margin is the amount that is left over once the costs of what is sold are paid. (How you price is important because it is the primary influencer of the gross profit margin and businesses go broke because of declining gross profit margin – in other words, your sales price is too low relative to the costs of the product you are selling.)
The formula for calculating a gross profit margin is as follows:
Gross Profit Margin = Sales Revenue – Costs of Goods Sold
For Example:
Tom Smith’s widget business has sales of $100 and cost of goods sold is $50.
Using the above formula, we can calculate that Tom Smith’s Gross Profit Margin is $50. Or, expressed in terms of the formula:
Gross margin = Sales Revenue – Cost of Goods Sold
$50 = $100 – $50 or as a percentage:
50% = 100% – 50%
Squeezing the Gross Profit Margin
So, do you want to know what happens when you:
- Reduce your price,
- Don’t increase price in line with cost increases or
- Partially increase your price in line with cost increases.
Check out this handy pdf: How to Calculate the Gross Profit Margin. Using this guide, you’ll be able to ensure you’re not pricing yourself out of business.
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