Lessons in Pricing: The Fallacy of Incremental Volume

The large paper companies have lots of smart people. Financial people. Marketing people. Engineers.

Lots of MBAs.

We can learn a lot from these smart people…from the mistakes they make.

Accountants will tell you that every order should cover full cost or it loses money. Makes sense. But paper company accountants also figured out how much downtime costs. Idle paper machines cost you a lot of money.

The same is true for printers and printing presses.

And some of the MBAs figured out that incremental volume can be very profitable. The fixed cost is already spent, so if you get an order for more tonnage (or for printers, more printing), it keeps the machines running and every dollar beyond variable cost goes right to the bottom line. Pure gravy.

Or, to put it another way, it’s better to have some contribution toward paying the overhead than no contribution. Makes sense.

The MBAs also figured out that what we were really selling is paper machine time, and lost machine time is lost forever. Just like press time. That makes sense, too.

Have you seen William Shatner in those “Priceline Negotiator” ads? Unsold hotel room nights are the same thing.

The math was right. The logic was right. So, what went wrong?

Of course, hotel rooms and paper machines and printing presses aren’t the same thing. But there are two bigger problems with the theory of incremental volume.

The first is that the incremental volume is not the lowest-cost business; it’s actually the highest-cost business. If you produce less and use less raw material, you will cut the most expensive production costs, not the least expensive. So the last unit of production, therefore, uses the highest-cost materials.

The bigger problem is that cutting prices can cost even more than downtime. I remember once asking the question, “What costs more, a five-percent price cut or two weeks of downtime across all of the mills? The first reaction is to say that the downtime is worse, but the answer is that the price cut costs more.

Jack Miller is founder and Principal Consultant at Market-Intell LLC, offering Need to Know™ market intelligence in paper, print and packaging. Previously, he was senior consultant, North America, with Pira International.

Known as the Paper Guru, Jack is the former director of Market Intelligence with Domtar, where he also held positions as regional sales manager, territory sales manager and product manager. He has presented at On Demand, RISI’s Global Outlook, PRIMIR, SustainCom World and at various IntertechPira conferences. Jack has written for Printing Impressions, Canadian Printer, Paper 360, PaperTree Letter and Package Printing, along with publishing a monthly e-newsletter, MarketIntellibits.

He holds a Bachelor of Arts degree in Economics from The College of the Holy Cross and has done graduate studies in Statistics and Finance.

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Comments
  • tatkerson

    I think with raw material costs rising for paper producers, most cannot afford to cut prices.

  • Steve

    Dear Jack: You are my new best friend! Great, well thought out message. Dropping price is easy, anyone can do it. Often called the "idiot down the street pricing."
    We feel helpless when faced with needing a lower price but as you say, "Not so fast." Anyone can drop or match a price, it takes a real man or woman to defend their value. More businesses go under from low, "discount" pricing than real value focused pricing. If I go down, I’d rather go down defending my services at a fair price than a "something, is better than nothing", mindset.

    Steve Counts

  • mr printer

    Incremental volume is very understated in this example. I do agree market stability is very important so be careful how and who you sell the incremental volume to.

    Incremental volume can save or kill a business, m and a did more to push up paper prices than anything else, now its time for printers to learn from that!

  • Aron

    "If you produce less and use less raw material, you will cut the most expensive production costs, not the least expensive" – Why is that? Please explain. if the machine is already set up and running, why are these the most expensive? . . . It is true however that if these last-unit items sit in a warehouse they quickly turn into the most expensive on the planet.

  • MrEnvelope

    The largest envelope mfg in the world prescribed to incremental pricing with all of the paper merchants, and look where it took them! They continue to facilitate this any revenue is good revenue approach to this day. Paper Mills keep going all in like it’s a poker game with them. The fact they "buy" orders, instead of "sell" orders is driven by the fact "money, i.e. controllers, etc." dictate the business philosophy within. Really, try selling something!

  • Erik Nikkanen

    I think you make a good point. But the theory is right but it needs to be supported by something that is more important.

    Lowering internal costs gives one the capability to be able to lower prices while still making profit. With sustainable lower internal costs, the lower prices can generate those incremental volumes that are then beneficial and are not so easy for competitors to match.

    Why is it that printers stop short of trying to reduce internal costs? I don’t know the answer to that or at least I don’t want to suggest why but from my perspective, printers limit themselves in thinking what is possible.

  • printkeg

    I still do not believe that two weeks downtime is better than a temporary 5% cut. If you can achieve more business by simply reducing prices by a mere 5% then your prices are likely too high in the first place.