Scanning downwards,
at the first level profit drivers are sales revenue and costs.
The sales revenue is in turn price times the sales volume.
Cost have obviously some variable and some fixed components.
Variable costs change, as you can imagine, with the sales volume, but
fixed costs do not.
Pricing's critical nature is readily seen by the dramatic impact
its effective management can have on the bottom line.
Pricing researchers have noted that the fastest and most effective way for
a company to realize its maximum profit is to get pricing right.
The right price can boost profit faster than increasing volume will.
The importance of pricing can be nicely supported by some research that was
done a couple of years ago by a consultancy firm in the United States.
They looked at 2,400 companies and they were wondering what would happen
if I can improve four different profitability drivers.
What would happen with the bottom line of these 2,400 companies on average?
They looked at volume, price, fixed cost, and variable cost.
What we see from this chart is that by reducing our fixed cost by only 1%,
we can actually drive the bottom line of these organizations,
on average, by more than 2%.
So we already see that all the four different profit drivers have
a significant impact on the bottom line.
Nevertheless, we see that pricing
is the most important driver of profitability of these organizations.
Just raising prices by 1% will actually lead to an increase in the bottom line
by more than 11%.
This finding was supported by some research that we did at
IE Business School a couple of years ago.
We looked in this particular case at the European market, and
we were interested in whether their strategic focus of an organization
has as well an impact on the profitability of the organization.
More specifically,
really focused on whether the organization follows more a cost focus or
whether that organization follows more a pricing focus, or price management focus.
As dependent variable, we focused on profitability,
here depicted by earnings before interest and tax.
What we could find from that research is that there's a clear correlation,
a clear relationship between the strategic focus of the organization and
the profitability of the organization.
In a nutshell, we can summarize this research that
companies that focus on price management are significantly more profitable
than companies focusing simply on the management of their costs.
Let's illustrate this with a very simple example in order to highlight
that price is one of the most important drivers of profitability.
Let's consider the following question.
Let's see what is the correct answer to this question.
Let's assume a very simple example.