Captain’s log, stardate 20180822
Sent by Jonathan Stark on August 23rd, 2018
Warning! Math ahead...
Let’s say you live near a popular campground. To make a little extra money, you and all your neighbors sell firewood at the end of your driveways for $3 per bundle.
For the sake of argument, let’s say that the effort it takes to fell, cut, split, stack, store, dry, package, and sell the firewood comes to roughly $2 per bundle on average.
Therefore at $3 per bundle, each sale nets you $1 of profit.
Brace yourself. Here comes the math part.
If you double your price per bundle you quadruple your profit per bundle.
Yep, it’s true.
Consider these two hypothetical scenarios:
10 bundles sold for $3 each equals $30 gross revenue. Subtract $20 in total cost and you’re left with $10 of net profit.
10 bundles sold for $6 each equals $60 gross revenue. Subtract $20 in total cost and you’re left with $40 of net profit.
Assuming you do absolutely nothing other than change the 3 to a 6 on your sign, you’re probably not going to sell as many bundles of wood as your neighbors who are selling them for $3 each.
However - pricing psychology being what it is - you’re still going to sell some bundles of wood at $6 a pop because a subset of people will assume that there’s something better about your wood simply because it’s more expensive.
Now here comes the magic of thinking in terms of net profits versus gross revenue:
You can sell half as many units at $6 a bundle as you would have at $3 a bundle and still double your profits!
This may seem to defy logic, but it’s simple math.
Consider our hypothetical scenarios again but this time with a different number of units sold:
10 bundles sold for $3 each equals $30 gross revenue, minus $20 in total cost results in $10 of profit.
5 bundles sold for $6 each equals $30 gross revenue, minus $10 and total cost results in $20 of profit.
In fact, you could go all the way down to selling only 3 bundles at $6 each and still be netting more money than you would by selling 10 bundles at $3 each. (i.e., $12 net profit on $18 gross revenue vs $10 net profit on $30 gross revenue)
Keep thinking about this until it’s crystal clear. This is one of the key concepts required to get you off the hamster wheel of trading time for money.
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