Suicidal Pricing

By John Roche, Haybrooke CEO

It’s one of the toughest decisions a printer has to make: how to price its products in the marketplace.

It’s tough, because there is generally no universally agreed benchmark price for any given printed product. This makes assessing what is a ‘good’ price for print or a ‘bad’ price for print, troublesome.

There is general agreement, however, that if you reduce your prices you will win more work. This strategy seems like a good idea. More work, means greater market share, means greater dominance, means – ultimately – greater profits, right?

The answer is ‘yes’ and ‘no’.

‘Yes’: because on paper this strategy seems to make perfect sense.

‘No’: because it often doesn’t work out this way.

Something not all printers seem to understand very well is the concept of demand ‘elasticity’. ‘Elasticity’ is just a fancy way of saying that the prices you tend in the market will affect a print buyer’s willingness to buy your printed products.

How is elasticity measured?

Well, consumer demand that is ‘inelastic’ means customers are not put off from buying a product or service if prices go up. A good example of this is car fuel. Generally, most folks need to put fuel in their cars to get around so, even when prices are hiked by the petroleum companies – as they often are – we continue to buy, regardless.

Consumer demand that is ‘elastic’ means customers are swayed by suppliers pricing as to whether or not they buy from them. The most elastic market – said to be almost ‘perfectly elastic’ – is money. If you are exchanging GBP for Euro’s to go on holiday, you will only accept a rate that is at, or very close to, the published current market exchange rate. If the broker deviates even marginally away from this, then you will likely lose interest completely.

Most of the time, products and services that are being consumed in any given marketplace sit somewhere in between. They are neither ‘perfectly inelastic’ nor ‘perfectly elastic’, but instead are ‘relatively inelastic’ or ‘relatively elastic’ – which simply means it sits somewhere in the middle. Exactly where in the middle, turns out to be very important indeed.

In a market that is ‘unitary elastic’ an increase in price corresponds to an exact decrease in demand; and a decrease in price corresponds to an exact increase in demand. Put simply, this means if you increase your prices by 20% across the board, the demand for your products will drop by 20%. On the other hand, if you decrease prices by 20%, the demand for your products will go up by 20%.

Think about this for a moment. If the print buying sector is unitary elastic (it almost certainly isn’t; more of this below) then it would never make any sense for a printer to ever change its prices!

Let’s do some maths. To keep it simple, let’s say a printer derives its revenues by charging £20 per 1000 printed sheets and it prints 50 million sheets per year. On this basis, its revenues will be:

(A)   50,000,000 sheets x £20 /1000 = £1,000,000 revenue

What will happen if the printer reduces its prices in a unitary elastic market?

Well, the demand for its products will increase in direct proportion to the drop in prices.

Say, the printer discounts prices by 25% and chooses to charge £16 per 1000 sheets (£20 / 1.25), rather than £20 per 1000. What then? Well, the increased demand for its printed products will mean the press will now produce 62.5 million sheets. Revenues will thus be:

(B)   62,500,000 sheets x £16 /1000 = £1,000,000 revenue

As you can see, in a unitary elastic market there is no advantage in reducing prices. Moreover, it might even be better to increase prices. Referring to the above, if a printer were to instead increase prices by 25% then it would now be charging £25 per 1000 sheets. However, productivity would reduce by 25% meaning printed sheets would now be 40 million. Revenues will now be:

(C)    40,000,000 sheets x £25 /1000 = £1,000,000 revenue

This might be better, because there is less work to do for the same return.

BUT and it is a big ‘but’, the printing industry is almost certainly not a unitary elastic market. It is, in fact, a relatively elastic marketplace. This means that if a printer were to increase its prices, a disproportionate amount of business would drop off. Conversely, if they were to decrease prices, they would win a disproportionate amount of new business.

The amount by which a given market deviates from being unitary elastic is measured by its ‘price elasticity’. Say this metric is not unitary in the printing industry, but is more elastic, it broadly means that any change to pricing will have an additional demand impact. Using the above example, if a printer reduces its prices by 25%, then the change to its revenues might now look like this:

(D)  75,000,000 sheets x £16 /1000 = £1,200,000 revenue

In this case, a reduction in prices of 25% resulted in a (positive) disproportionate increase in demand of 50%, not 25%. As measured, however, 50% more productivity did not result in 50% more revenues; due to the drop in prices. In fact, a 50% increase in demand (equivalent to a 50% increase in productive output) corresponded to just a 20% increase in overall revenues.

Broadly speaking, this would allow one to state that a 50% increase in productivity results in a 20% increase in revenues. BUT – and it is another very big ‘but’ – revenues does not mean ‘profit’.

A printer derives its profits from adding a mark-up to the cost price. In all of the above examples, let’s assume that the revenues cited represent the printer’s operational costs. It then adds a 5% mark-up to all jobs to generate a profit. Here is a table of the profits derived from the above scenarios:

(A)   £50,000 profit [standard pricing, unitary elastic]

(B)   £50,000 profit [-25% prices / +25% demand / unitary elastic]

(C)   £50,000 profit [+25% prices / -25% demand / unitary elastic]

(D)  £60,000 profit [-25% prices / + 50% demand / relatively elastic]

This seems to support the idea that profit grows directly in line with revenues. However, if a printing company were to drop its prices by 25% to increase demand for its products (by 50% here) this new work does not gravitate toward it of its own volition; nor might its current machinery be able to cope with the increase.

As a result, the printing company might have to invest in new equipment and machinery in order to execute its plan and also has to market its new pricing structure to (potentially new) customers in order to win the desired new share of the marketplace. This can result in a considerable increase in its cost of sales (COS).

If we assume that for every 10% increase in demand/production there is a corresponding increase in the COS of 1%, then an increase in demand of 50% represents new costs of sales introduced to the printing company of 5%. This will reduce the amount of profit available to it, as follows.

(A)   £50,000 profit [standard pricing / unitary elastic]

(B)   £37,500 profit [-25% prices / +25% demand / unitary elastic / +2.5% COS]

(C)   £50,000 profit [+25% prices / -25% demand / unitary elastic]

(D)  £30,000 profit [-25% prices / + 50% demand / relatively elastic / +5% COS]

Model ‘D’ is that which a lot of printers seem to be exploring at the moment, so let’s sum it up in words for deeper understanding.

With a £1 million turnover, if you reduce selling prices by 25% it will attract 50% more business. This, in turn, will increase sales revenues by 20% up to £1.2 million but simultaneously add 5% to your cost of sales. With a 5% mark-up applied to all jobs it will, thus, reduce overall profitability by 40% from £50,000 to £30,000.

This is quite a surprising result; that an increase in productivity and workflow of 50% might actually hurt profitability by as much as 40%. So are there any real-life examples of this?

In fact there are.

In November 2016, it was announced in Printweek that Falkland Press were embarking on a new era of productivity, driven by the purchase of a new printing press and new, highly-productive working methods. One month before the new press was commissioned the company recorded a turnover of £4.9 million and made a profit of £773k (as per its Y/E Sept 2016 accounts). By any reasonable measure, a 16% pre-tax profit is an impressive trading performance in what is a very tough selling market.

One year later and the company had achieved its ambition of enhancing the productivity of its operation. This resulted in a significant increase in sales. The heightened productivity measures it now employed combined with lower pricing saw revenues (as per its Y/E Sept 2017 accounts) grow from £4.9 million to £5.9 million – an increase of 20%. If the earlier analysis is correct, this would correspond to an increase in productive output of c. 50%. However, almost in keeping with these scenarios, its operating profit fell by 37% and its pre-tax profit fell by 52% to £367k (6%).

This might just be the inevitable pain of investment having to be funded over a prescribed term; or it might be the early signs of choppy waters ahead – only time will tell.

Either way, there is no doubt that ongoing investments by printers are required to maintain a healthy business outlook. However, if these investments are being made solely to drive sales revenues though cheaper prices, then ‘price elasticity demand‘ (PED) needs to be fully understood before making the final decision.

Where it is not, a printer might just end up becoming the next ‘busy fool’.