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The Midsomer margin killer

Rishi Sunak’s Eat Out to Help Out experiment will soon be ending. His novel tactic of subsidising meals out on the quietest 3 days of the week was designed to get local economies moving again by luring us out of our protective bubbles and back into pubs and restaurants: a price cut to boost demand.

But what of those of us in other business sectors? We’re not going to get a government subsidy but should we follow suit and try to boost demand with a price cut?

Let me introduce you to Walter Rose, owner of Walt Rose’s Fine Foods in the seemingly idyllic Somerset/Dorset border village of Midsomer Carnage. Along with other locally sourced products he sells lemon drizzle cakes supplied by master baker Holly Pinewood. He pays Holly £2 for each cake, adds a 50% mark up and sells an average of 100 per week at £3 each giving him a weekly gross profit of £100. One evening while eating out to help out in Midsomer Carnage’s Italian gastro-pub, The Strozzapreti (Priest Strangler), a bloke called Aldo tells him he could sell a lot more cakes if only he’d reduce the price.

Walt decides to cut prices by 10% to £2.70 and reckons this will help him sell 20% more cakes, so he orders 120 from Holly. Sure enough they all sell at the new lower price. But look at his profit:

                                                Before                  After

Cakes sold                           100                         120

Price                                      £3.00                     £2.70

Sales value                          300                         324

Cost                                      200                         240

Gross profit                        £100                       £84

Despite selling 20% more cakes and increasing the money going through the till the price cut has killed his margins and his profit has fallen by 16%. If you do the maths he would actually need to sell a staggering 42% more cakes each week just to maintain his profit.

Of course there are times when discounting makes good commercial sense. Some things will be unsaleable if left until tomorrow: ripe bananas, tonight’s hotel rooms, and last season’s trainers.

Before cutting prices to increase volume you might want to think about:

  • Price conscious customers are less loyal than those attracted by quality.
  • If you carry stock or sell on credit terms you may have more money tied up.
  • Don’t forget other hidden variable costs: card merchanting, delivery.
  • As with Walt, more customers may simply mean running faster just to stand still.

If you’re contemplating reducing your prices you can use our breakeven calculator to quickly work out how much more you need to sell to avoid losing profit.