Pricing and Profits

What should you do if the rate of return from a line of business is inadequate? The obvious solution is to raise prices. Unfortunately, like many obvious strategies, this one will often be wrong. If a product line yields an inadequate return on investment, four strategies should be explored.

1. Make sure your price is not too high or too low. Return to the maximum pricing formula and see if you calculated incorrectly, or whether your estimate of the price elasticity of demand was inaccurate.

Elasticity Price

−1.5 $30.00

−2.5 $16.67

−3.5 $14.00

−4.5 $12.86

−5.5 $12.22

−6.5 $11.82

−7.5 $11.54

−8.5 $11.33

−9.5 $11.18

2. Reassess your estimate of incremental costs. If it is too high, your prices will also be too high, and vice versa.

3. See how much you can cut your costs. Most healthcare firms should be able to reduce costs substantially. To see whether yours can be brought down, take a look at costs and business practices in firms you think are efficient.

4. If all else fails, exit the line of business.

The consequences of setting price incorrectly can be substantial. The profit-maximizing price should be $15.00. Setting a price much lower or much higher than $15.00 reduces profits significantly. Note, though, that being a bit too high or a bit too low is not disastrous. Being a little off in your estimates of incremental cost or the price elasticity of demand will usually mean your profits will be a little smaller than they could have been.