As a business owner or entrepreneur, one of the most important goals you have is to maximize revenue. This can be done in multiple ways through increasing sales and cutting costs, but understanding marginal revenue is the prerequisite of your success. In simple words, marginal revenue is the additional revenue you earn from selling one more unit of a product or service.
This article will help you calculate your marginal revenue and use it to make informed decisions about your business. Whether you’re a seasoned business owner or just starting out, we’ll provide you with the knowledge you need to maximize your revenue and achieve your business goals.
What is marginal revenue and why is it important?
As we’ve already mentioned, marginal revenue is the increase in revenue earned from selling one additional unit of a product or service.
It’s important to understand marginal revenue because it helps businesses make informed decisions about pricing, production, and marketing strategies. By understanding marginal revenue, businesses can identify their optimal pricing strategy, determine the level of production needed to maximize profits, and use it to maximize their marketing decisions.
For example, let’s say you sell t-shirts for $20 each. If you sell 100 t-shirts, your total revenue would be $2,000. If you sold one more t-shirt for $20, your total revenue would increase to $2,020. The marginal revenue earned from selling one more t-shirt is $20.
Knowing the marginal revenue helps businesses understand the value of each additional unit sold.
How to calculate marginal revenue
Calculating marginal revenue can be done with a simple formula. In mathematical terms the formula for marginal revenue looks as follows:
Marginal Revenue = Change in Total Revenue / Change in Quantity Sold
Let’s look at the steps you need to take:
Step 1. Calculate your change in total revenue – subtract your initial revenue from your current revenue.
Step 2. Determine the change in quantity sold – subtract the initial quantity of product from the current product quantity.
Step 3. Take the change in total revenue, and divide it by the change in quantity sold.
Let’s use the t-shirt example from before. If you sold 100 t-shirts for $20 each, your total revenue would be $2,000. If you sold the 101th t-shirt, your total revenue would increase to $2,020. Using the formula above, the marginal revenue would be:
Marginal Revenue = ($2,020 – $2,000) / (101 – 100) = $20
This means that for every additional t-shirt sold, the business would earn an additional $20 in revenue.
It’s important to note that marginal revenue can be negative if the additional unit sold results in a decrease in total revenue. For example, if a business lowers its price to sell more units, it may experience a decrease in total revenue due to the lower price per unit.
Common mistakes to avoid when calculating marginal revenue
There are a few common mistakes that businesses should avoid when calculating marginal revenue.
The first mistake is assuming that the marginal revenue will remain constant as more units are sold. Marginal revenue can change as the level of production and pricing changes.
Another mistake is assuming that the marginal revenue will always be positive. Marginal revenue can be negative if the additional unit sold results in a decrease in total revenue.
Finally, businesses should avoid using marginal revenue as the sole factor in decision-making. Marginal revenue should be used in conjunction with other factors such as fixed costs, variable costs, and market demand.
Using marginal revenue to determine optimal pricing strategies
One of the main uses of marginal revenue is to determine the optimal pricing strategy for a business. By understanding the marginal revenue, businesses can identify the price point where they can maximize profits.
A business can use marginal revenue to determine the optimal price point by comparing it to the marginal cost. Marginal cost is the cost of producing one additional unit of a product or service. The optimal price point is where the marginal revenue equals the marginal cost.
For example, let’s say a business sells cupcakes for $2 each. If the marginal cost of producing one more cupcake is $1, then the optimal price point would be where the marginal revenue equals $1. If the business sells a cupcake for $2 and the marginal cost is $1, the marginal revenue would be $1. If the business lowers the price to $1.50, the marginal revenue would be $0.50. This means that the business would need to sell more cupcakes to make up for the decrease in price.
Find out how to choose the optimal pricing strategy for your business.
Incorporating marginal revenue into production decisions
Marginal revenue can also be used to make better production decisions. By understanding the marginal revenue, businesses can determine the level of production needed to maximize profits.
To determine the optimal level of production, businesses once again can use the marginal revenue and marginal cost. The optimal level of production is where the marginal revenue equals the marginal cost.
For example, let’s say a business produces 100 cupcakes for $50 in total cost. If the marginal revenue for selling one more cupcake is $2 and the marginal cost of producing one more cupcake is $1, the optimal level of production would be to produce more cupcakes until the marginal revenue equals the marginal cost. In this case, the business would want to produce more cupcakes until the marginal revenue is $1.
Check out how data-driven insights can help you grow your business.
Using marginal revenue to improve marketing strategies
Marginal revenue can also be used to improve marketing strategies. By understanding the marginal revenue, businesses can identify the most profitable products and services to promote.
For example, let’s say a business sells t-shirts and hats. If the marginal revenue for selling one more t-shirt is $20 and the marginal revenue for selling one more hat is $10, the business should focus its marketing efforts on promoting t-shirts.
By focusing on the product with the higher marginal revenue, the business can maximize its profits. This way, you can make sure you advertise popular products and achieve better ROAS.
Looking to increase your sales? Check out which marketing strategies will help you make the most of your products.
Taking your e-commerce business to the next level with Synder Business Insights
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Synder Business Insights is an automated analytics tool that provides you with real-time analytics on a single dashboard so that you can draw insights from one source of truth and make better decisions about your e-commerce business. Connect all your sales and payment channels and get access to actionable KPI reports on your revenue, product and customer performance.
With Synder Business Insights, you’ll know what your revenue is at any given moment, and you’ll be able to break down the reports by channel, time period, and customize it to your needs. The tool will also allow you to find new ways of increasing revenue with product bundling, spot the seasonality trends, understand your customers better, and much more.
Sign up for a 15-day free trial to try out Synder Business Insights yourself, or check out how Synder can help you know the real numbers of your business by booking office hours with one of our specialists. Unlock the true potential of your e-commerce business!
Maximizing revenue is a top priority for businesses. By understanding marginal revenue, businesses can make informed decisions about pricing, production, and marketing strategies.
Calculating marginal revenue is a simple process once you know the formula. By using the relationship between marginal revenue and marginal cost, businesses can determine the optimal price point and level of production needed to maximize profits. What’s more, with the marginal revenue analysis, businesses can focus on promoting the most profitable products and services.
Using the right analytics software will help you keep tabs on the most important KPIs for your business and make sure your revenue is under control at all times. By drawing insights from your performance and incorporating marginal revenue analysis into your business strategy, you’ll take your business to the next level and maximize profits.