Knowing when to up the price of your product or service is no easy feat. There are a lot of factors to take into account, including outgoing costs, financial performance, and market demand.
And if you make changes at the wrong time, you risk losing customers to competitors.
To make this process a little easier, you might want to try using the marginal revenue formula.
If you’re not familiar with it, don’t worry. In this article, we’ll look at the ins and outs of the marginal revenue formula and how you can use it to scale your business.
But before we get into the thick of it, let’s clarify what marginal revenue actually is.
Marginal revenue is the amount of revenue generated from selling extra units of a product or service. It’s used to calculate the financial benefits of producing a higher quantity of products.
Let’s use an example to demonstrate.
Imagine that you sell your first 50 units for $10 per product. You priced your products at $10 each based on your production costs and desired profit margin.
On top of the initial 50 units, you sell an additional 5 products for $10 each. This is the marginal revenue. With this information, you can make informed decisions about pricing and production costs.
Marginal revenue changes depending on the change of production price of the additional unit. To decide whether a production change is cost-effective, businesses will weigh up the revenue increase or decrease with the original output. This will then be compared with the new projected output.
For instance, if a business changes one or more parts of its production process, it can use the marginal revenue to determine the selling price.
Businesses can also use marginal revenue to determine when and how to incrementally up their sale price. This is often used to compensate for higher production costs without affecting the demand curve or the number of units sold. A lot of businesses do this in highly competitive markets.
The marginal revenue formula (sometimes known as the sales revenue formula) divides the change in total revenue by the change in total output quantity.
Here’s how the formula is displayed:
Using this formula, businesses can accurately identify the marginal revenue.
Marginal cost is the additional cost required to produce an additional item.
So if you sold five additional units for $50, the marginal cost is the price paid to produce each additional unit.
As long as the marginal revenue is higher than the marginal cost, businesses will be making a profit. When the marginal cost is higher than the marginal revenue, the business should consider stopping production or sales or risk losing money.
The marginal revenue curve represents the relation between marginal revenue (revenue generated by additional units sold) and the number of units sold.
You’ll need to produce the number of units found at the intersection between the marginal revenue curve and the marginal cost curve to maximize profit.
Various changes to the marketplace can cause the marginal revenue curve to shift, so it’s important to track it regularly. The curve will also change depending on whether you’re operating under perfect competition or imperfect competition.
Let’s look at this in more detail.
In this situation, multiple companies are operating in the same marketplace.
When a single company changes its supply, it doesn’t impact the total price in the market. Because there are so many companies operating in this marketplace, companies will always get the same price for every unit. To price too high would mean losing customers to fairly-priced competitors.
As a result, companies set their unit prices level to their marginal revenue.
Here’s an example of a marginal revenue curve under perfect competition.
As you can see, the marginal revenue is a straight, horizontal line that represents the standard market price.
Under imperfect competition (sometimes known as a monopoly), one company dominates the market. Changes in its product line and level of output can impact market prices and the industry as a whole.
Simply put, the price and number of units are determined by the monopolist. They’ll make their decision based on how best to maximize profits. In most markets, the monopolist will lower its price to increase output.
With a monopoly, the price of units lowers every time the company increases its output. Other companies will then need to lower their prices to sell more units, which can diminish the marginal revenue.
In this situation, the marginal revenue is on a downward slope. Here’s an example:
As you can see, the marginal revenue sits under the demand curve. The gain from selling more units is lower than the market price.
The average revenue per user (ARPU) is the average price a customer pays for one unit. You can calculate the average revenue by dividing your total revenue by the quantity sold:
Using the average revenue formula, businesses can estimate their profits and make informed business decisions. Here’s how it can help:
With all this information, businesses have a better understanding of their financial health and how to allocate their resources.
Marginal revenue and average revenue are similar concepts. It’s for this reason that people often confuse the two formulas.
Figuring out which formula to use depends on what you want to measure.
Marginal revenue measures the relationship between change in total revenue and quantities sold. For this reason, it should be used to identify when it’s the best time to up your production efforts.
Average revenue doesn’t take changes into account and is a bit more rigid in its structure. If you want to determine how to price your products, use average revenue.
Now that we’ve covered a lot of ground and clarified what marginal revenue is, let’s look at some of its main advantages.
To grow your business, you need to increase your revenue. Period. Without additional money coming in, you won’t have the resources you need to expand successfully .
This is where marginal revenue can help.
The marginal revenue formula measures the increase in revenue from selling more products. It allows businesses to analyze options to maximize earnings while preserving savings.
For example, if your marginal revenue is growing, you know that you need to think about upping your production and reviewing your prices. This is also known as a cost-benefit analysis.
But without marginal revenue, you might not be able to compare production costs with revenue so easily. This means you could miss an opportunity for growth and overlook increasing customer demand.
Understanding your marginal revenue helps you make informed business decisions.
Think about it. When you’re tracking the marginal revenue, you’re measuring the increase in revenue from selling more units. With this information, you can make informed pricing and production decisions that help your business succeed.
Without this information, your business decisions could lack alignment and direction. Somewhere down the line, this could result in a pretty sticky financial situation for your company.
Using the marginal revenue formula, you can identify if and how it's financially viable to offer products that meet consumer demand.
But why is it important to meet consumer demand?
Understanding consumer demand allows you to provide customers with the products and services they’re looking for. It keeps them happy and helps your business grow.
If you’re giving customers what they want, they’ll have a good perception of your brand. And when a customer has a good relationship with your brand, they’re more likely to buy from you. 71% of consumers will buy from a brand they trust.
By understanding your marginal revenue, you can see when consumer demand is growing and prepare your business to meet customer needs. In doing so, you’re building a rapport with your target market and encouraging them to buy from you.
You know what marginal revenue is and how to use it. Now, it’s time to think about how you can put the marginal revenue into action and grow your business.
A good place to start is by reviewing your production processes and costs.
Why?
Because with lower production costs, you’re far more likely to see an increase in the marginal revenue. And when the marginal revenue starts to increase, you can look at increasing your output and upping your prices — both of which will help your business grow and succeed.
So keep reading to familiarize yourself with some efficient ways you can reduce your production costs and increase your marginal revenue.
We’ll start by looking inward and optimizing your existing processes. This is a great way to reduce your costs and streamline your production process.
To get yourself started, here’s what we’d suggest:
In a world where almost 27% of businesses are predicted to work remotely, technology plays a pretty important role in the day-to-day running of business operations.
But how cost-efficient is your technology?
It’s not uncommon to stick with a piece of software because you’re used to it. You get comfortable and forget that there might be other options better suited to your needs and budget.
So spend some time looking at the software you’re currently using and compare it with what else is out there. In doing so, you might find something that saves you money and provides you with a better service.
If you can reduce your outgoing costs for materials or services, you might see an increase in marginal revenue.
Negotiating prices can be tricky, especially with suppliers that already feel they’re giving you a good deal.
Here’s some advice for trying to negotiate:
As we already know, marginal revenue increases when the revenue received from an additional unit of sale grows faster than the cost of production.
Getting more consumers to purchase can help you reach that extra unit sale and increase your marginal revenue.
But reaching new customers is easier said than done. Not to mention, the best way to attract new customers varies from business to business. What works well for one company might not be the best bet for you.
Ultimately, it’s up to you to figure out how best to reach your target audience and encourage them to make a purchase.
Whether you offer unique deals and discounts with promo codes for new customers or use promotional marketing to reach more customers — only you’ll know the best way to attract your target audience.
Using the marginal revenue formula is never a linear process. Unless your prices never change and the marketplace stays the same, your marginal revenue will fluctuate. Depending on how it looks at any given time will determine where your focus needs to be.
If marginal revenue is high, take a look at expanding your production efforts. If it’s low, think about what you can do to increase it.
At this stage, you should have a pretty sound knowledge of the marginal revenue formula and how to use it. Now, it’s time to review your marginal revenue and figure out where your business stands.
If things are looking good and you want to attract more customers, take a look at the discounts other companies are offering on the CouponFollow website. You might find some inspiration for your own deals and offers.