Legendary investor Warren Buffett once said that “the single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business.”
Maybe you believe all your clients are price sensitive and therefore only consider price increases when cash flow is weak. Maybe you don’t pay much attention to pricing because everything else on the to-do list feels more urgent. You focus on running a good business, bringing in new customers, managing costs, and keeping your team on track. Pricing sits in the background, set once and rarely revisited, while the rest of the business gets all the attention.
In either case, it’s understandable. If you attended business school, it’s highly unlikely that you even had a full course on pricing, much less had it offered as a field of study. When you’re out running your business, you can find all manner of outside resources in marketing, operations, accounting, and so forth, but very little if anything on pricing.
A book the title of which I hate, Small Business for Dummies, illustrates the lack of attention pricing receives. Out of 464 pages, only about 4 ½ pages, just 1% of the book, are devoted to pricing.
The math most owners never run
Meanwhile, costs keep moving up. If your pricing isn’t at least keeping pace, you’re not standing still; you’re losing ground. Here’s what that actually looks like on a real income statement.
Let’s use a hypothetical business to understand the power of pricing in changing the bottom line, either for ill or for the better. Our business owner “Eddie” has a well-run, nicely profitable business. Eddie’s Business pulls in $5 million in revenue annually, $2.1 million in cost of goods sold, $2.9 million in gross profit, $2.4 million in fixed costs, and $500,000 in net profit at the end of the year.
Eddie’s fixed costs, rent, salaries, and overhead don’t move no matter what he charges. When he raises prices modestly, almost every new dollar of revenue drops straight to profit, because the costs required to serve that same customer haven’t changed. When he cuts price to chase volume, the opposite happens: he’s serving more customers at a lower margin, and his variable costs climb right along with them. That’s why a small price increase creates an outsized profit gain, and why a price cut does outsized damage, even when the percentage move looks modest on paper.
Watch what happens to that same $500,000 in net profit under three different pricing decisions.
- Eddie decides to cut his price 10% to win more customers. The 10% price drop and the 10% volume gain nearly cancel out, so revenue barely moves, but the added volume drives up variable costs. Net profit falls from $500,000 to $240,000. More than half of Eddie’s profit vanishes.
- Eddie raises the price 1% and keeps every customer. Revenue ticks up slightly, and costs stay flat. Net profit rises to $550,000, a 10% profit gain from a 1% price move.
- Eddie raises the price 10% and keeps every customer. Revenue grows, costs stay flat, and net profit doubles to $1,000,000.
Realistically, some price-sensitive customers may leave when Eddie raises the price. Suppose he loses 10% of his customers, a meaningful hit. His profit still climbs to $660,000, a 32% gain over where he started. Even a pessimistic outcome for Eddie ends better than what comes from the fear of doing nothing.
Why pricing beats every other growth strategy
Every other growth strategy a business might try costs something. More marketing or hiring more salespeople requires new spending, and both yield an uncertain return. It might take months or even years to show up in the numbers.
Pricing is different. It costs nothing to test. You control the outcome directly. The results show up almost immediately.
That’s what makes it free money. It’s not that price changes are easy, but that they are the only lever available to you as a business owner that doesn’t require you to spend anything or wait months to find out if it works.
This is why changes in pricing are the fastest way to change your bottom line. It’s not just my opinion; it’s an accounting fact.
The lever that’s already in your hands
Every other growth strategy requires you to go find something new: new customers, new capital, or new resources. A price increase doesn’t. The customers are already yours, the product or service is already built, and the value you deliver already exists. All that’s left is deciding whether customers see enough value in your product or service that they accept the price increase.
Warren Buffett called pricing power the single most important decision in evaluating a business. He didn’t say it was the hardest, just the most important. It’s a lever sitting right there on your desk.
