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Optimising profit

I’m going to talk a little about profit optimisation here. Principally, this is because I’m going to refer back to it later.

If your market is above a certain (variable) minimum size, profit optimisation involves setting a price that maximises the amount of profit you would receive from sales of goods and/or services.

On the surface, this might appear to be “what the market will bear” (ie: The highest price that the market will tolerate paying), but this maximum price typically generates much smaller profits than the optimum.

Every potential customer has a “sweet spot”; a price at which purchase becomes a no-brainer for them, where their perception of the value of the goods and services to them outweighs the cost. Every customer’s sweet-spot differs, because each customer assesses the value according to different, subjective, criteria.

That might make finding the optimum point quite difficult, but when it comes to your aggregated market, your profits always respond to a fairly simple curve. In actuality, the curve might be a little bit more ragged, but the basic shape tends to be the same.

No, Penfold. Optimising profit, not Optimus Pr--... Oh, never mind. Do come along.

For every extra dollar the price rises, you get an extra dollar per unit sold in clear profit, but the number of sales decline, which is fewer units sold.

Your own sweet-spot is the top of the peak, at the point where overall profit is maximised and any further rise will cut into that profit by reducing your sales.

In practice, sellers periodically adjust the prices of goods upwards – or downwards in the form of periodic sales – to make sure that they’re actually riding that peak. If total profits rise in response to a price-rise, then the new price will settle there, until the next test. If total profits fall, during the test period, the basic price remains the same, unless a sale shows better profits from lower prices.

Generally, when new products and services are introduced to a market – unless there are huge development deficits to recoup – the price at which they’re introduced is relatively modest, and are then progressively ramped up until the sweet-spot is reached.

Often this is done on a per-region basis, as different countries and cultures evaluate the value of goods and services differently. Some countries are less price-sensitive to certain foods, but more price-sensitive to computer hardware, for example. This leads to situations like the markets for books, DVDs and video games, where the prices of products may vary widely from region-to-region, absent any other factors.

The downside of this model is that if your market is too tiny, the shape of the curve breaks down and there is no clear sweet-spot, just a jumble of localised minima and maxima, which will shift and change over time.

Now that we’ve gotten that out of the way, I can refer to it later, and save us all some time.

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Categories: Business, How To, Opinion.

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