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We spend an enormous amount of time trying to figure out how to grow revenue. More customers. New markets. Additional products. More salespeople.
And all of those things can work.
But there’s something interesting about pricing improvement that I think a lot of business owners overlook. We can increase the profitability of a business without adding a single customer, hiring another employee, or expanding into another market.
And the impact on what our business is worth can be substantial.
I’m talking about a 5% price increase potentially creating more than $1 million in additional business value.
Same customers. Same team. Same work.
Why Pricing Improvement Can Be More Profitable Than Revenue Growth
When we bring in a new customer, there’s a cost associated with that revenue. Someone has to sell the work, onboard the customer, and then actually deliver whatever we’ve promised.
Expanding into a new market requires investment. Developing a new product requires investment. Even growing our existing customer base usually means additional people, systems, or resources.
But what happens when we increase the price of work we’re already doing?
Think about it.
The customer is already there. Our team already knows how to deliver the service. We’ve already built the infrastructure necessary to fulfill the work.
So when we charge more for that same service, most of the additional revenue goes directly to profit.
In fact, the incremental revenue from pricing improvement on existing work can convert to EBITDA at approximately 80% to 95%.
That’s a very different outcome from acquiring new revenue that comes with additional delivery costs.
And when we start thinking about our business as an asset rather than simply a source of income, that difference becomes incredibly important.
How a 5% Pricing Improvement Creates $1 Million in Business Value
Imagine we own a business doing $6 million in annual revenue.
Our gross margin is 35%, which means we’re generating $2.1 million in gross profit. After our operating expenses, we’re producing $900,000 in EBITDA, a 15% margin.
Now imagine we increase prices by 5% across 80% of our existing revenue base.
We’re allowing for some customers who may not accept the increase.
That gives us $240,000 in additional annual revenue.
Assuming 90% of that additional revenue converts to EBITDA, we’ve just increased annual EBITDA by $216,000.
Look at what happened:
- Original EBITDA: $900,000
- Additional EBITDA: $216,000
- New EBITDA: $1,116,000
- EBITDA improvement: 24%
We didn’t have to increase our customer count. We didn’t have to add employees.
We improved pricing on work we were already doing.
Now here’s where this becomes really interesting.
If our business is valued at five times EBITDA, that additional $216,000 represents approximately $1.08 million in additional enterprise value.
From a 5% price increase applied to part of our revenue base.
That’s why private equity firms pay so much attention to pricing improvement. They understand that relatively small changes in profitability can have an outsized impact on what a company is worth.
And that’s a lesson we should be applying long before we’re ready to sell.
The Discount Problem We Don’t Pay Enough Attention To
There’s another side of pricing that deserves just as much attention.
Discounting.
We’ve all had situations where reducing our price seemed like the right decision. Maybe we wanted to win a customer. Maybe we were concerned about losing an existing relationship.
And sometimes discounting makes sense.
The problem starts when those individual decisions accumulate and nobody is measuring what they’re actually costing us.
Consider a professional services business generating $4 million annually, with average discounts of 12% across its customer base.
Using that revenue as the calculation base, those discounts represent $480,000 in annual pricing concessions.
At a 35% gross margin, that would represent $168,000 if those concessions were evaluated using the existing gross margin.
But the actual profit opportunity from restoring prices can be larger because the cost of delivering the work may not change.
And there’s another problem.
Customers eventually stop seeing their discount as a discount.
If someone has been paying 12% below list price for three years, they don’t necessarily think they’re getting special treatment anymore.
They think that’s simply what your service costs.
Now imagine trying to bring them back to your normal rate.
Removing a 12% discount requires an effective price increase of approximately 13.6%.
That’s a much harder conversation than making a reasonable annual adjustment with someone who’s been paying your standard rate all along.
And this is why unmanaged discounting can become such an expensive habit.
We’re not just giving up revenue this year. We’re creating expectations that make it harder to recover that revenue in future years.
What a 1% Pricing Improvement Is Actually Worth
Sometimes the percentages are so small that we dismiss them.
What’s another 1% really going to do?
Quite a bit, actually.
Imagine a service business generating $5 million annually, with a 35% gross margin and a 12% EBITDA margin.
That means we’re currently producing $600,000 in annual EBITDA.
A 1% pricing improvement generates $50,000 in additional revenue. At a 90% EBITDA conversion rate, that’s approximately $45,000 in additional EBITDA.
Our EBITDA just increased 7.5%.
Now compare that with increasing sales volume by 1%.
We still generate $50,000 in additional revenue, but we have to deliver the additional work. At a 35% contribution margin, that creates approximately $17,500 in additional EBITDA.
That’s an improvement of about 2.9%.
A 1% reduction in our $4.4 million cost base would save $44,000, improving EBITDA by approximately 7.3%, assuming the savings flow through completely.
Cost reduction can be valuable too. But there’s a limit to how much we can cut before we begin affecting the business’s ability to operate.
And volume growth requires us to keep finding and serving additional customers.
Accepted pricing improvement can continue benefiting the business year after year, provided we retain the customers and maintain the higher rates.
That’s why pricing improvement deserves a much more serious place in our planning.
We Need to Think Beyond What the Business Pays Us
I think this is where the owner-operator and owner-investor mindsets start to separate.
When we’re focused entirely on operating the business, we naturally spend our time thinking about revenue. How do we sell more? How do we grow faster? How do we keep everyone busy?
Those are legitimate questions.
But if our goal is to build something valuable enough to eventually sell, or to create lasting wealth for our families, we have to start asking a different question.
How much more valuable could this business become if we improved what we’re already earning?
Because a business generating more revenue isn’t necessarily becoming more valuable at the same rate.
What matters is how much of that revenue becomes sustainable profit.
And how much someone would be willing to pay for that profit.
Private equity understands this. Pricing is often one of the first areas they examine because improvements can produce meaningful results without the expense and uncertainty of pursuing entirely new revenue.
Take a serious look at your current pricing. Look at the discounts you’ve been giving. Look at how long some customers have been paying the same rates.
Then calculate what even a 1% improvement would mean for your EBITDA and the value of your company.
You may discover that you’ve been working incredibly hard to grow a business while overlooking one of the simplest ways to make the business you already own worth more.
And I think that’s the part worth sitting with.
Because someday, whether we sell the business or pass it on to the next generation, the question won’t just be how much money we made along the way.
It’ll be how much of that work we actually turned into wealth.
And how much we left sitting on the table.
Justin D Maxwell provides family office and investment bank services to the lower midmarket to founders who want 8 or 9 figure net worths. You can learn more here: www.justindmaxwell.com or take our free assessment here: https://fielding.global/articles/diagnostic.html