Study: Lowering prices will not increase profits
A Banana Republic customer looks at her receipt as she leaves a store in San Francisco
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Kai Ryssdal: A lot of companies are finding themselves caught between a sluggish consumer market, in this economy, and rising production costs. Procter and Gamble said today profits are down and margins are getting squeezed by high commodity prices. But P&G says it's not planning to raise retail prices.
Marketplace's Alisa Roth explains why that might not be the corporate world's best strategy.
Alisa Roth: Like a lot of small business owners, Liz Walters started running into trouble around the time the economy fell apart in 2008. She owns a yarn shop in San Diego.
Liz Walters: My customers seem to be very price-sensitive. Everyone is stepping down one quality level in what they're buying.
She started cutting prices, about 10 percent for expensive yarns. And she's still frequently has 25-percent-off sales.
But an analysis from McKinsey, the consulting firm, suggests that might do more harm than good for small businesses like Walters, and big ones like Procter and Gamble.
McKinsey created a model based on 1,200 companies. It found that increasing the price of a product or service by 1 percent could boost the company's profits by almost 9 percent if sales stayed the same.
But lower the price enough to make customers notice -- by say 5 percent -- and the company would have to increase sales by double digits, just to break even.
That just isn't realistic in today's economy. Mike Marn is one of the authors of the McKinsey report.
Mike Marn: The message here is that the basic math of decreasing price to increase volume, to increase profits, just does not compute for almost every large and small company in the world today.
John Zhang is a marketing professor at Wharton. He says a lot of customers don't even notice when companies charge a little bit more.
John Zhang: Not all the customers really care about the prices.
Which means companies may actually have more pricing power than they think.
In New York, I'm Alisa Roth for Marketplace.