Lessons in Pricing: The Fallacy of Incremental Volume

The price cut takes five percent of sales right off the bottom line, but the downtime represents less than five percent of a year’s output. And when production is down, you are not consuming raw materials or energy, and some labor costs might also be reduced. Moreover, it’s an opportunity to catch up on maintenance.

• True, the price cut might be temporary, but it rarely is.

• True, the price cut might only apply to “incremental volume,” but that idea is flawed.

I’ll never forget the time that I took an “incremental” order for a large volume of paper at a price that was “below market.” Within an hour, I got a call from a paper merchant who was also bidding on that business. He knew he lost that order, and even though I told him nothing, he had a pretty good idea of what happened and where the price point must have been. That meant he knew where he had to be on price the next time. That “isolated” order affected the market and wasn’t so isolated after all.

We need to remember that what looks good in theory doesn’t always work out that way in the real world. Customers and competitors react in ways that don’t always fit the theory.

So which is the right approach? Only sell above full cost, or take the incremental volume? In reality, you need to look at it both ways, and then use good judgment.

It is true that incremental volume at discounted prices can add cash flow and provide positive margin or contribution, but it’s a slippery slope; those discounted prices can very quickly become the market price. And once the market price goes down, it doesn’t come back easily.

If there is any doubt, don’t cut the price.