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Size a margin uplift in two numbers: basis points of revenue and dollars of EBIT. Then say which margin you mean. A move from a 20% to a 22% gross margin is 200 basis points, two percentage points and a 10% relative increase. Those are three statements about one change, and a board paper that mixes them will be challenged.
What are the three ways to describe the same change?
For a move from a 20% to a 22% gross margin:
- Basis points: 200 bps.
- Percentage points: 2 points.
- Relative increase in the margin: 10%.
Use basis points when comparing across products, customers or years. Use dollars when the decision is about money. Keep the relative increase for the rare case where the reader asked for it.
What does a worked example show?
This example is hypothetical, and it is the same illustrative business used on the Pricing Insight methodology page: revenue A$100m, variable costs A$70m, fixed costs A$20m and EBIT A$10m. The contribution margin is 30%. Each change below is made on its own, with all else equal.
- 1% better price, no loss of volume: EBIT rises by A$1.0m, or 10%.
- 1% lower variable cost: EBIT rises by A$0.7m, or 7%.
- 1% more volume: EBIT rises by A$0.3m, or 3%.
- 1% lower fixed cost: EBIT rises by A$0.2m, or 2%.
These ratios belong to this cost structure. A business with a different mix of fixed and variable cost gets different ratios, so do not carry the 10% into your own paper without rebuilding it.
A price rise also carries a volume risk. In this example a 1% price rise stops adding EBIT if volume falls by more than about 3.2%. That figure assumes variable costs fall with volume and fixed costs stay put. At a 3% price rise, the volume loss that cancels the gain is about 9.1%.
What should you check before you quote the number?
- Net, not list. Measure the uplift on the price customers pay after discounts and rebates.
- One margin. Gross margin, contribution margin and EBIT margin move by different amounts. Name the one you are using.
- Revenue is not EBIT. Added revenue only becomes EBIT after the costs that come with it.
- No double counting. Estimates for different fixes overlap. Do not add them together.
- Estimate or result. Pricing Insight moves an opportunity through five stages before calling it a benefit: measured exposure, peer benchmark, addressable, expected benefit and realised benefit. A figure from stage one or two is an estimate.
Next step
The Pricing Insight methodology sets out how each stage is sized, and a Pricing Diagnostic and Quick Wins measures the opportunity from your own sales history.
