A Rule of Thumb in Pricing

Pricing is complex, which is why we love it.  But we also love those rare instances where we can use simple rules of thumb as a shortcut.  We’ve been using this one for years:

 By simply taking one over your GM% rate, you can find a breakpoint for your elasticity.  Here’s an example:

Let’s say you’re making 20% margin on your products.  The math is pretty easy: -1/20% is -5.  That  -5 result would have to be your elasticity if you’re maximizing your GM dollars.  To bring the -5 elasticity measure to life, ask yourself the following question.  If you were to take 10% off your prices, would your unit volume go up by:

  • Less than 50%?  Then you’re priced too low.
  • About 50%?  You’re about right for profit maximizing price.
  • More than 50%?   Then you’re priced too high.

We’ve spoken at length before about how there’s more to pricing than simple profit, but it’s always handy to have something a simple thought experiment to help guide the math.