Driving Sales Volume & Revenue In A Price-Sensitive Market

Driving Sales Volume & Revenue In A Price-Sensitive Market
Stewart Anderson Angelo Lyall KAIZEN SOLUTIONS INC.

The current economic climate
The recession has been an extremely disruptive economic event. Despite some signs of recovery, demand is still depressed and price sensitivity is high in many markets. The prevalent response of many firms to the recession has been to cut costs, cut costs, and cut more costs to maintain profitability.

You’ve cut costs and leaned…
…but revenues and profits are still down, and growth is slow at best. Now what? …maybe it’s time to get back in touch with fundamentals: if you can’t generate sustainable revenue, you may struggle in a price-sensitive marketplace.

The purpose of a business…
…is to create a customer (Peter Drucker). If you can’t create customers, there is no business! Value is what creates customers. Insight: Creating value is not the same thing as reducing waste.

About value Economic value is created when a business makes a product whose perceived benefit (B) exceeds the costs (C) incurred. V = B - C Value is divided between customers and producers. Benefit less Price (B – P) represents the portion of the value created that is captured by the customer. Price less Cost (P – C) represents the portion of the value created that is captured by the producer.

Driving Sales Volume & Revenue
In a price-sensitive market, there are two prevailing strategic pathways to choose from or combine. Those pathways are: 1) Cost Advantage 2) Benefit Advantage

Cost Advantage arises through a firm’s ability to decrease their cost structure in a way that competitors cannot imitate, and then pass on some of the savings to the customer in the form of lower prices.

Benefit Advantage arises from the ability to identify things that the customer values that are not offered by competitors, and using these unique offerings to attract sales without compromising margin.

Along with the definition of each strategic option, it is important to understand how each works from an economic perspective so that we may understand the forces that govern them and the reasons that their advantages arise.

P D Q P = Price Q = Quantity D = Demand

P P 1 D Q Q 1 P1 = Current Price Q1 = Current Quantity Demanded

P P 1 D Q Q Q 1 2 Q2 = Desired Sales Volume

P P 1 D Q Q Q 1 2 There are two ways to drive sales volume to Q2. One way is to adjust price through a Cost Advantage. A change in price is shown as a change in the point on the demand curve.

P P 1 D 2 D Q Q Q 1 2 The second way to drive sales volume is to influence the demand curve to shift to the Right using a Benefit Advantage.

To better understand the implications of each option, let’s play out each strategic path and see the results.

P P 1 P 2 D Q Q Q 1 2 First let’s explore the effect of price-cutting WITHOUT having first reduced cost-structure through a true Cost Advantage.

P P 1 P 2 D Q Q Q 1 2 The price cut has accomplished the goal of Increasing sales volume to the desired quantity, but what are the implications of such a strategy?

P P 1 P 2 D Q Q Q 1 2 Where is the firm’s bottom line? How will this impact the firm?

P P 1 P B 2 D Q Q Q 1 2 B = Bottom Line

P P 1 P B 2 D Q Q Q 1 2 The profit margin is the difference between the price and the bottom line. We can see that the price cut has left the firm with a severely diminished profit margin on the product.

P P 1 P B 2 D Q Q Q 1 2 In the long-term, competitors will respond by adjusting their own prices until your price advantage is negated.

P P 1 P B 2 D D 2 Q Q Q 1 2 The demand curve shifts to the left, reflecting the market’s expectation for the product to be provided at a lower price industry-wide.

P P B 2 D Q Q 1 With a lower margin, and tighter price expectations from customers, the price advantage is extinct and sales volume will Eventually decrease back to Q1.

P P B 2 D Q Q 1 The long-run outcome of this scenario is an acceptance of lower profit margins and equal or very slightly increased sales.

P P B 2 D Q Q 1 For a firm to cope with such a scenario could require a drastic reduction in cost-structure and could lead a firm to reduce labour and other costs sources, or even to exit the market.

P P B 2 D Q Q 1 Sales Volume is increased in the short-run, but decreases again in the long-run. Profit is not maximized because while Sales Volume is temporarily inflated, the increase comes with a decrease in profit margin.

P P B 2 D Q Q 1 Price-cutting is NOT Cost Advantage. Decreasing prices without a true Cost Advantage can be extremely harmful to a firm in the long-run.

P P 1 B 1 D Q Q 1 A true Cost-Advantage strategy works as follows:

P P 1 B B 1 2 D Q Q 1 First, The firm must discover a way to reduce its cost structure that is unique and that competitors cannot replicate.

P P 1 P 2 B 2 D Q Q Q 1 2 Second, the firm reduces prices while maintaining their profit margin.

P P 2 B 2 D Q Q 2 The result of a proper Cost-Advantage strategy is a lower price offering to the customer and maintenance of profit margin while forcing competitors to accept lower profit margins or leave the market.

How to Obtain a Cost Advantage: Many firms think that they have a cost advantage simply because they exercise a strategy of offering lower prices than their competitors. True Cost Advantage arises through a firm’s ability to decrease their cost structure in a way that competitors cannot imitate, and then pass on some of the savings to the customer in the form of lower prices. E.G. Unique process structure and/or technologies.

P P 1 D Q Q Q 1 2 Now let’s explore the second option for driving sales volume through a Benefit Advantage. Let’s influence a shift in the demand curve rather than cutting price to change the point on the current one.

P P 1 D 2 D Q Q Q 1 2 By influencing a shift in the demand curve itself, the firm achieves their target sales volume of Q2.

P P 1 D B 2 D Q Q Q 1 2 Equally important, is the fact that the increase in demand did not require a decrease in profit margins.

P P 1 D B 2 D Q Q Q 1 2 The long-term result is an increase in Sales Volume without eroding profit margin or initiating price wars.

P P 1 D B 2 Q Q 2 A Benefit Advantage forces competitor firms to cut prices without having first lowered their cost structures.

How to Obtain a Benefit Advantage: Many firms fall into the trap of thinking that adhering to quality or lead-time expectations gives them benefit advantage. True Benefit Advantage arises from the ability to identify things that the customer values that are not offered by competitors, and using these unique offerings to attract sales without compromising margin. E.G. Designing or packaging products in a way that allows the customer to reduce their own cost structure.

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