Marketing Mix is the set of controllable, tactical marketing tools you use to reach and influence buyers along the path to purchase.
The Marketing Mix links all 4 Ps of marketing: Product, Place, Promotion and Price. It’s a pretty simple concept; but we’ve found that it can be difficult for some marketers to put an effective strategy in place without it. Fortunately, there are great frameworks like this one from Marketo (we love their platform) which make it easy!
Many managers try to set prices by adding together all production costs but soon find out that they are losing money because sales are too low. One reason sales are too low is that the resulting price is simply not competitive with what competitors charge for similar products or services . The other is that customers do not flock to buy because they do not value what you offer enough to make it worth the price.
There is a saying in the world of economics: “If you take away competition, you get socialism.” The same principle applies to pricing strategy: if costs and costs alone determine prices, your prices will be too high and sales will suffer. This is frequently the case when companies set prices based on total cost rather than marginal or variable costs that vary with unit sales . Understanding this principle is important because it means that you must shift portfolio emphasis from lower cost (with higher gross margins) to higher margin products and services offered through different distribution channels.
Focusing On Revenue, Not Profits
Companies often try to maximize revenue by offering deep discounts in order to generate volume sales. The problem is that they do not realize that by giving away discounts and incentives , they sabotage the quality of their products and services and ruin their chances for future profits! Discounting may turn temporarily profitable transactions into unprofitable ones, which usually results in a loss.
Remember, each product or service sold at full price contributes more to profit than one sold below cost . Thus, the objective should be to maximize your gross margin (price less variable costs) rather than revenue (price times units). A quick test: if you gave away all of your products and services – free – would you make any money? If no – stop discounting now.
Maximizing Profits vs. Revenues: Understanding economics reveals the truth about maximizing revenues.
In economics, revenue is the total amount of money a company brings in from sales of products and services before expenses are deducted. It’s that simple. The income statement or profit and loss statement reports all revenues and all expenses for a specific accounting period , usually a year.
Expenses vary with volume of sales. As you sell more units, your variable costs go down . If you increase prices, your fixed costs do not change but your contribution margin increases (i.e., the difference between price and variable cost). In other words, it takes fewer units to generate higher profits because average fixed costs are spread over more units sold at higher prices. This is why increasing prices while offering discounts should be avoided: you are focused on increasing revenues rather than profits .
Maximizing Profits vs. Revenues: How discounts decrease profitability.
Volume Discount Example: If you can sell twice as many widgets at 50% off, your revenue will double . But the loss on each unit sold will also double ! The more you give away in discounting, the more money you lose! This is what makes promotional pricing strategies so dangerous if not performed correctly. They are likely to cause short term losses even though you increase revenue during that time frame.
Profit = Total Sales – Total Costs
Understand that maximizing profit means maximizing margin (the difference between sales and costs). Thus, it makes sense to maximize sales of higher items by offering lower prices, thereby increasing profit because higher margin items carry lower costs .
Let’s assume you sell widgets for $100. If it costs $60 to make them, your profit is $40 per widget (sales minus variable costs). But let’s say you offer a discount through a volume purchase program, and customers can buy widgets at 50% off the original price . Your revenue doubles to $200 , but that means that each unit sold will now cost you $120 (full price less 50% off), which results in only $80 of profit ( revenue of $200 minus expenses of 60).
Volume Discount Example: The more discounts offered , the lower your profits. You may think this example is too simple or obvious, so let me present this next example to demonstrate the greed factor.
Consider this example: What if your widgets are selling at $200 each with a profit of $40 per unit, and you discover that it is now possible to buy the widgets from an overseas supplier for only $50 each! You can now offer even greater discounts on larger volume purchases. Your revenue doubles again to $400 , but because your costs have also doubled , your net profit remains at $40 per unit (total sales of $400 minus total costs of 200).
Volume Discount Example: The more price concessions given away, the lower your profits .
The problem is that once you sell these same widgets at 50% off they now cost you $100 each. This means that every time one is sold, it will cost you $100 in variable costs (full price less 50% discount) and contribute only $50 per unit to your revenue. This results in a net loss of $40 per unit on each widget sold! And if you give away even deeper discounts, you could potentially lose money on every sale and go out of business quickly .
Maximizing Profits: How discounts increase expenses.
In general, the more products prices are discounted , the higher the expense for maintaining that pricing strategy . For every price cut there must be an offsetting action to generate profit from it . While increasing expenses may result in increased revenue, this is usually insufficient to recover additional fixed costs. In other words, although sales volume increases with higher discounts offered, the increase in expenses tends to offset this revenue growth .
In general , each additional unit sold at a lower price requires even deeper discounts, which may offset any additional revenue generated. This point is aptly demonstrated by this NFL ticket discounting example:
Increasing Profits via Price Increases vs. Volume Discounts.
When raising prices, profits go up because one’s sale price must exceed their cost to steal business away from competitors (cut throat price war) . Thus, it is important to raise prices of higher margin items first before raising lower margin items . For instance, an advertising agency typically raises its higher margin clients’ fees more than its lower margin clients’ fees before increasing their own bid rates on new projects. Higher profit margins allow you to raise prices more frequently and by larger amounts.
The key to success is making sure you can still cover all variable costs, but this shouldn’t be difficult as long as your cost per unit doesn’t increase dramatically . For example, if a widget costs $60 to make and it’s selling for $100 , then there’s $40 of margin to give away. But if the price increases just 20% — say to $120 — that allows you to offer discounts on even higher volume purchases! The trick is that with higher margins, the costs associated with those discounts don’t become such a big percentage of sales revenue. Thus, increasing prices always trumps discounting in terms of profitability .