Decisions to modify pricing, especially price increases, are one of the most powerful yet misunderstood levers for bolstering company profitability. Over the past decade or so, the most common misconception I have encountered among executives — regardless of industry, company size, or geography — is the belief that the relationship between price increases and bottom-line results is linear. This flawed understanding often leads companies to leave substantial profits on the table and be overly resistant to pricing decisions that could maximize earnings before interest, taxes, depreciation, and amortization (EBITDA).

This mathematical reality stems from a relatively simple concept. When prices increase while costs remain unchanged, every incremental dollar flows directly to the bottom line. Many executives argue that raising prices is unlikely to increase overall profitability due to customer/volume attrition. In reality, the relationship between price increases and EBITDA is highly nonlinear when product or service costs are constant. Consequently, price increases can dramatically enhance overall profitability even with moderate volume loss.

As an illustrative example, let’s consider an overly simplistic scenario of a company that sells only one product, with entirely variable costs and the following profitability profile:

  • Average sale price per unit: $200
  • Annual units sold: 50,000
  • Annual revenue: $10 million ($200 x 50,000)
  • Cost of goods sold (COGS) per unit (variable costs): $180
  • Gross profit per unit: $20 ($200 – $180)
  • Annual COGS: $9 million ($180 x 50,000)
  • Current EBITDA: $1 million ($10 million – $9 million)
  • Current EBITDA margin: 10 percent ($20/$200)

Now imagine this company implementing a 10 percent price increase across its product line. Many executives would mistakenly conclude that this translates to a 10 percent increase in profits; however, the math shows a dramatically different outcome:

Scenario 1: No Customer Loss

  • Average sale price per unit: $220 ($200 x 110 percent)
  • Annual units sold: 50,000
  • New annual revenue: $11 million (10 percent increase)
  • COGS per unit (variable costs): $180 (unchanged)
  • Gross profit per unit: $40 (100 percent increase)
  • Annual COGS: $9 million
  • New EBITDA: $2 million (100 percent increase)
  • New EBITDA margin: 18.2 percent

In this ideal scenario, a 10 percent price increase actually doubles EBITDA from $1 million to $2 million. This 100 percent increase in EBITDA occurs as a result of the price increase flowing directly to the bottom line as costs remain unchanged.

Scenario 2: With Customer/Volume Attrition

Even assuming the company loses 25 percent of its volume due to the price increase, the company still increases its EBITDA relative to previous pricing:

  • Average sale price per unit: $220
  • Annual units sold: 37,500 (50,000 x .75, to adjust for a 25 percent decline in volume)
  • New annual revenue: $8.25 million ($220 x 37,500)
  • COGS per unit (variable costs): $180 (unchanged)
  • Gross profit per unit: $40 (100 percent increase)
  • Annual COGS: $6.75 million ($180 x 37,500)
  • New EBITDA: $1.5 million (50 percent change)
  • New EBITDA margin: 18.2 percent

Despite losing 25 percent of its volume, the company still increases EBITDA by 50 percent. This counterintuitive result demonstrates the nonlinear relationship between pricing and profitability when costs remain unchanged.

Scenario 3: Break-Even Analysis

Understanding your pricing break-even point — the maximum volume loss you can sustain while maintaining current profits — is a critical factor when considering pricing decisions. The formula is straightforward:

Breakeven volume loss = price increase / (price increase + gross margin percentage)

In our simple example above:

  • Gross margin percentage = 10 percent ($20 gross margin / $200 average sale price)
  • Price increase = 10 percent
  • Breakeven volume loss = 10 percent / (10 percent + 10 percent) = 50 percent

This means the company could lose up to 50 percent of its volume from the 10 percent price increase and still maintain its current EBITDA levels. Any volume retention above 50 percent creates incremental profit.

Case Study: Health-Care Distributor Pricing

A health-care distributor that I advised was hesitant to implement price increases for a branded drug after the manufacturer raised the client’s cost of goods sold.

After analyzing customer price elasticity, we implemented targeted price increases averaging 10 to 15 percent across roughly 25 stock-keeping units of the branded drug. The empirical results from the price increases were astonishing to the client:

  • Customer volume fell by only 1 to 3 percent.
  • Net revenue rose by 10 to 20 percent over the following six months.
  • Overall EBITDA dollars increased by more than 30 percent.

As a result of the price increase, the client achieved around a 30 percent improvement in EBITDA from a modest 10 percent price increase, along with hundreds of thousands of dollars of incremental EBITDA, even after factoring in the loss of some customer volume.

Conclusion

The nonlinear relationship between price and EBITDA represents one of the most powerful and underutilized profit levers available to businesses. By understanding the mathematical reality between price increase and EBITDA, businesses can make more optimal pricing decisions that significantly improve financial performance even as they deal with reasonable levels of volume loss.

 

Brad Maltz W07, president of Brad Maltz Consulting Inc., is a pricing and profitability expert and has assisted clients in generating more than $125 million in incremental annual EBITDA via pricing and procurement initiatives.