The owner of a small electrical contracting firm spends most of the year chasing growth. He runs online ads, networks at business breakfasts and offers free quotes to anyone who asks. Turnover creeps up a little each year. Profit barely moves.
When his accountant takes a closer look, the reason becomes clear. Almost every job leaves the firm cheaper than it was quoted. A “goodwill” discount here, a call-out fee waived there, an extra socket fitted for free, a 10% reduction for a client who mentioned a competitor’s quote. None of these felt significant at the time. Together, they had quietly taken a large slice out of every job’s profit.
Most small business owners think of growth as selling more. That’s natural, and important. But one of the most cited pieces of pricing research suggests that, for many businesses, a small improvement in the price actually achieved can do more for profit than a much bigger push on sales.
One Like insight: A small change in what you actually charge can do more for profit than a big change in how much you sell.
The power of 1%
In 1992, Michael Marn and Robert Rosiello, both pricing specialists at McKinsey & Company, published an article in Harvard Business Review called “Managing Price, Gaining Profit”. They used the average economics of 2,463 companies to compare four ways a business can improve profit.
For a company with average economics, a 1% improvement in volume, selling 1% more, increased operating profit by 3.3%. A 1% cut in fixed costs added 2.3%, and a 1% cut in variable costs added 7.8%. But a 1% improvement in price, with no loss of sales, increases operating profit by 11.1%. The authors concluded that improvements in price typically have three to four times the effect on profitability of the same percentage increase in volume.
The logic is simple. Extra volume brings extra costs: materials, time, fuel. Extra price, if customers accept it, falls almost entirely to profit. The same arithmetic works painfully in reverse. A 1% price cut, on those average economics, wipes out 11.1% of operating profit.
These are averages from large US companies in the early 1990s, and the exact numbers will be different for every business depending on its margins. A business with very thin margins sees an even bigger effect; one with very high margins sees a smaller one. And raising prices only helps if customers don’t leave as a result. But the principle is robust, and McKinsey’s more recent analyses have reached similar conclusions.
Where price quietly leaks away
Marn and Rosiello’s most practical insight was that many businesses lose money in the gap between their list price and what they actually collect. They called this gap the “pocket price waterfall”: a series of small reductions, each reasonable on its own, that together erode the final price.
For small businesses, the waterfall usually includes a few familiar items:
- Ad hoc discounts given to win or keep a job, often without a clear rule.
- Waived fees, such as call-out charges, delivery or setup.
- Unbilled extras, the “while I’m here” jobs done for free.
- Late or partial payments, which cost money in time and cash flow, as we explored in Why We Don’t Chase the Money We’re Owed.
- Old prices that never moved, while costs rose every year.
None of these feels like a pricing decision at the time. That’s exactly why they matter. Because they aren’t tracked, they’re rarely questioned.
[Infographic placement] The price waterfall. A descending bar chart for a single R10,000 job. Quoted price: R10,000 → Goodwill discount: −R800 → Call-out fee waived: −R450 → Free extra work: −R600 → Late payment cost: −R150 → Price actually collected: R8,000. Beneath: A 1% price improvement increased operating profit by 11.1% on average across 2,463 companies (Marn and Rosiello, 1992).
Plugging the leaks
Start by tracing your own waterfall. Take your last twenty jobs or sales and compare the price quoted or listed with the amount actually received. Note every discount, waived fee and free extra. Most owners are surprised by the total.
Then set a few simple rules. Decide in advance when discounts are allowed and how large they can be. Charge for call-outs and extras, or decide deliberately when not to. Review your prices at least once a year, rather than leaving them unchanged while costs rise. And if you do raise prices, explain the value clearly and consider starting with new customers first.
It’s worth adding a word of caution. Price increases need to be matched by real value, and some customers will leave. As we explored in Your Price Is Part of Your Product, price also shapes how customers see you, so it should fit your position in the market.
A few questions can help:
- What do we actually collect, on average, compared with what we quote?
- When did we last review our prices, and have our costs risen since?
- Who in the business can give discounts, and under what rules?
- What extras do we routinely give away without deciding to?
Which brings us back to the electrical contractor chasing growth through ads and breakfasts. By setting a clear discount policy, charging for call-outs and billing for extras, he might add only a few percent to the average price of each job. On his firm’s margins, that could do more for profit than a year of networking, and it would only take an afternoon to start.
Sources
- Michael V. Marn and Robert L. Rosiello, “Managing Price, Gaining Profit”, Harvard Business Review, September–October 1992.
