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Raising prices to increase gross margin is one of the most effective and most overlooked options a business has to increase profitability. How can you raise prices without driving away your customers?
When business owners are asked how they hope to increase profit in the coming year, there are three answers: increase sales, reduce expenses and the least popular response — increase prices to increase gross margin. Regardless of the size of your business, if you plan to increase profitability this coming year you must implement some combination of these three alternatives.
Most cleaning contractors are concerned that a price increase will mean fewer customers are willing to purchase their services. The effect of price on the demand for a service is called the elasticity of demand. If a price increase results in only a small or no decrease in sales, the demand for the services is said to be inelastic. Conversely, where sales drop significantly as a result of a price increase, the demand for the service is said to be elastic.
The objective of raising or lowering the price for a particular service is to increase gross margin or to stimulate total sales. Before changing your pricing for any cleaning service you offer, you should consider how price-sensitive your customers will be to the price change.
Most cleaning contractors feel that their industry is the most competitive of all industries. Furthermore, they feel that the particular city where they conduct business is also the most competitive for the services they are selling. As a cleaning contractor, you cannot compete with your larger competitors on price alone and be profitable. The economies of scale are on their side. To be successful, contractors must sell their services based upon how their cleaning services are different from their competitors.
Referring to the example (see figure 1), let’s assume your company is currently doing $1.5 million in annual sales, with a gross margin of 25 percent, or $375,000, as shown. Currently, your expenses are at 20 percent, or $300,000. Your current pretax profit is 5 percent or $75,000.
What if you could increase the price on services that you feel are not as price-sensitive as your general cleaning services? Customers draw conclusions about your entire pricing structure based upon the price competitiveness of your primary services.
Selectively, you could increase the price of these other add-on services to possibly increase your overall gross margin by, let’s say, 1/2 percent. Should you be able to accomplish this goal, your pretax profit would increase to $85,000, as shown (see figure 2).
The overall purpose of selectively increasing prices is to increase profit, even though the result may be a decrease in the volume of services performed. Be careful when increasing the price of all the services you offer. Doing so may adversely affect your pretax profit.
Why do people buy your cleaning services? Because they need your services or because they want your services? When people need something, they buy based on price. When they want products or services, emotion enters the buying decision and price moves down the decision ladder. When this occurs price is less important and you are able to increase your price and gross margin.
It is your job as a manager to train your employees to turn customers’ needs into wants, so that the person making the purchase decision is driven more by emotion than price.
In summary, to accomplish a higher gross margin for your cleaning contacting business, do two things. First, identify which services you provide that are less price sensitive and begin improving your bottom line by increasing the price you charge for these services. Second, train your employees to understand the difference between customers’ needs and wants, and how to appeal to them emotionally.
Figure 1 Condensed Profit & Loss Statement
Figure 2 Increase Gross Margin by 1/2 percent
(1) For the purpose of this example, it is assumed that the increase in the net sales figure was accomplished by simply increasing the sales price of certain additional cleaning services sold on a selective basis. The total services sold and the sales efforts have remained constant. Therefore, total expenses will not change from the $300,000 in the original example. |
Bob Langdon, CPA is a consultant and author of “Managing Your Business for Profit.” He can be reached at 303-377-3131. He will be speaking at ISSA/INTERCLEAN® North America in Orlando, Fla., on Tuesday, Oct. 23. His presentation titled “Three Routes to Increased Profitability in Your Contract Cleaning Business” is sponsored by Contracting Profits.