There are four key ways in which we typically try to do better in business/improve profitability.
- Offer a cheaper product with the belief that improved affordability will increase the size of the target market.
- Offer a better product (at the same or higher price) with the belief that customers will appreciate the value of a better product and pay the premium to buy it.
- Increase revenue by increasing the number of units sold (either through larger production or expansion of geography or a better marketing push) or increasing the price (by offering better products?).
- Cut costs. This would help you do better in terms of profitability at the same revenue levels.
While all the above are seen to operate, my personal belief is that a combination of 2. and 3. is the best strategy to adopt. The other two may be good in case of a late life cycle product. While it is another question as to what/how you define late life cycle products, it is certain that such products would either have significantly cheaper substitutes (so cheap that it is close to my manufacturing costs) which weren’t initially found OR the need for the product is fast vanishing altogether (a standalone music system with multiple CD/DVD players?). In either case, the product would soon die and your company would die too unless you develop a better product.
A note by consultants at McKinsey on pricing, gets me thinking on the increasing volume vs cutting cost options. According to them, “a price rise of 1 percent, if volumes remained stable, would generate an 8 percent increase in operating profits—an impact nearly 50 percent greater than that of a 1 percent fall in variable costs such as materials and direct labor and more than three times greater than the impact of a 1 percent increase in volume.”
This means that a 1% reduction in cost has greater positive impact on profitability than 1% increase in volume! It also means that increasing pricing is the surefire way to bumping up your profitability. This is from a study on S&P 1500 companies.
Caution: Know when and how you can increase your prices.
Needs more thought.