[IMGCAP(1)]My father’s largest client was a luggage manufacturer with a national brand sold in specialty luggage stores, but not in department stores.
He did this because he wanted to maintain the selling price, did not want discounting and felt his customer base would be more loyal if they did not compete against the larger stores’ discounting policy. He was very successful and very profitable, but probably not as large as he could have been had he had the volume that department stores would have provided.
When my father died I took over as the luggage manufacturer’s accountant, and my first day there we had lunch. He explained his pricing philosophy: He never gave discounts, but he did offer his customers a break while building up his sales in the slow months after Christmas season by announcing a price increase for March 1, along with six-month dating on orders placed in January and February. He even agreed to hold the inventory and ship it when the store needed it. That way he always got his full markup, the stores got theirs, the stores had a full line to sell, but didn’t have to stock it until needed, and the perception of his product was as high-quality luggage since it was never discounted.
He then handed me the last five years of financial statements my father had prepared for him and told me that I seemed smart, so I should go through them and tell him how much richer he would have been had he given 20 percent off! The 20 percent off didn’t work.
At some point later on, I became concerned about how he could increase his market share and profitability, and prepared an analysis with the purpose of showing how much more he would make if he dropped his prices by various percentage points. The upshot of my work was that it was easier to make more money if he raised prices than if he lowered them.
My analysis included not only dollar sales but also units of his products sold and a “calculation” of the physical units of added or lost sales he would need to increase his profit. One example of what the analysis showed was that at a 40 percent gross margin and a 10 percent price increase would yield more profits as long as the units sold did not drop by more than 20 percent.
On the other hand, if he dropped his price by 10 percent, he would need an increase in units sold greater than 33 percent before he would start making more money. The client now had to determine if his customer base was so weak that he would lose as much as 20 percent of his unit volume because of the price increase. Contrarily, would he gain more than a one-third increase in sales with the modest 10 percent price cut? Neither seemed probable, so he continued his pricing policy.
Note that there are other reasons to reduce prices such as using the product as a loss leader for other more profitable or repetitive sales, to reach a new customer base, to introduce your product or brand to the marketplace, to make you a “player” in that product line, to hurt or thwart a competitor, to quickly fill a previously unfilled need and myriad other reasons—some smart and some stupid.
FYI, the dollar sales volume of the price changes were much less exaggerated, but did not tell the right story. An additional consideration was the need to focus on the production consequences.
The takeaway here is that CPAs help clients see the big picture. Measuring and evaluating what is being sold is one method. Dollars are never the product.
Edward Mendlowitz, CPA, is a partner in WithumSmith+Brown, PC, CPAs. He has authored 20 books and has written hundreds of articles for business and professional journals and newsletters plus a Tax Loophole article for every issue of TaxHotline for 27 years. Ed also writes a blog twice a week that addresses issues his clients have at www.partners-network.com. He is the winner of the Lawler Award for the best article published during 2001 in the Journal of Accountancy. He has also taught in the MBA graduate program at Fairleigh Dickinson University, and is admitted to practice before the U.S. Tax Court. Ed welcomes practice management questions and he can be reached at WithumSmith+Brown, One Spring Street, New Brunswick, N.J. 08901, (732) 964-9329, email@example.com.