Growing the business – Is it required? And why you need a sound pricing strategy

Why does a business need to grow?  The question might sound very fundamental, but most of us in our personal lives want to settle and take it easy after sometime (read 35+ years of age), especially when the going is good. It’s not uncommon to notice this complacency in businesses as well, especially when the numbers are being met and everything looks seemingly good.

History has shown many businesses get into the comfort zone and are soon displaced by new technology, changing market needs, changing environment etc. (Kodak, Nokia, Kingfisher Airlines are some names that come to my mind).

Thus growth is essential to business sustenance, being status quo means you are complacent and the end is near!! (That might sound a little extreme).

Given that growth is an absolute necessity, what options does a business have to grow?

a.       Expand geographies

b.      Enter new verticals

c.       Have better channels and distribution

d.      Make new products that provide more value

e.      New business model

Most of the above options require an additional spend in terms of Sales & Administration costs or R&D costs. Thus while increased sales are good, they are not sufficient if the profit margins remain flat, or only marginally grow. In the below example, I assumed certain fictitious numbers, note that the gross margin remains the same. The op margin depends on the SG&A and R&D costs, if they marginally increase or decrease, the op margin changes accordingly.

Key Takeaway – Margins don’t change a lot by only increasing sales.

	Current Sales	Increased Sales
Revenue	100	200
COGS	75	150
Gross Margin	25	50 (25%)
SG&A	17	32
R&D	4	6
Op Income	4 (4%)	12 (5%)

Option 1 – Reduce Costs

By reducing costs – this typically translates to value engineering in engineering/product development firms. Let’s assume we are able to achieve a 10% reduction in costs

	Current Sales	Current Sales at reduced costs	Increased Sales	Increased Sales at reduced costs
Revenue	100	100	200	200
COGS	75	67.5	150	135
Gross Margin	25	32.5	50 (25%)	65(32.5%)
SG&A	17	17	32	32
R&D	4	4	6	6
Op Income	4 (4%)	11.5 (11.5%)	12 (5%)	27(13.5%)

Here we can see that a 10% reduction in cost results in almost a 7% -8%, increase in op margins. This is assuming no extra effort is spend by R&D, Sales in value engineering.

The first step businesses take is controlling costs, hiring freezes, travel freeze, reduced benefits etc. It’s a quick measure to keep the margins even when sales are dipping. However this is a short term measure, in the long run, beyond a certain point you can do much to control costs without it impacting your sales.

For e.g. new products pipeline might dry up due to controlled costs on hiring, R&D. Sales and channel reach might reduced to reduced spend on sales and marketing activities.

Thus, while cost control is a good short term measure, it will have long term implications if sustained for too long. Of course, cutting flamboyance from the system in a long term basis is always sustainable.

Option 2 – Increase Price

If it is possible to increase the price by 10%, then it has tremendous impact on the bottom line. Refer to the illustration below.

  

	Current Sales	Current Sales at increased price (10%)
Revenue	100	110
COGS	75	75
Gross Margin	25	35
SG&A	17	17
R&D	4	4
Op Income	4 (4%)	14 (19%)

A s illustrated, a good pricing can result in a direct translation to the bottom line accentuating the need for a good pricing strategy.

To summarize, a business needs to look at ways to improve top line(revenue) and bottom line( margins) to stay in the game and be ahead of competition.

In the next post I shall explore the different options that are available to price your product, skimming, penetration and value based pricing will be some terms that I shall explore.