Here is a hint… It has to do with pricing power… And that can lead to lot of fun things.
Pricing products or services is a very complicated decision. And yet, it is probably the most important decision small business owners need make. Charge too little for your products and you will leave money on the table. Charge too much and you will lose customers and sales. You have to strike a perfect balance between the two ends of the spectrum to come up with the price that your customers will be willing to pay for and enable you to make money. No wonder pricing is considered both and art and science.
Many small business owners hold myth that they can attract more customers and increase their sales simply by reducing the price. Nothing could be further from truth. The move may work initially, but it will put you in trouble at the end. We will explain why in a minute.
Before we do, though, let’s consider how business makes money. In its simplest form, the money you make is a result of price times quantity (P x Q). You can focus on either one to improve the cash flow. Most of the time, however, you will be able to focus on one or the other, but not both. You can charge high price by providing high value, high quality products (think BMW) but you will not be able to sell many units. Similarly, you can charge lower price for average quality products (think Chevrolet) and sell many units. The end result may still be good in either situation. It’s business owners’ decision as to where they want to play the game.
In our view, it is prudent for small business owners to focus on higher value, higher price game than trying to compete on low price. There are several reasons for this as explained below.
- As a small business competing with larger corporations, there is no way you can win the game on price. Large companies have enormous buying power. Besides, they can spread their fixed costs over large number of units they sell lowering their breakeven point. Just talk to any small and medium size businesses who have tried to compete with Wal-Mart on price!
- No matter how much lower you can get your price there will always be someone who will match or beat you. Someone who is interested in growth at any cost and doesn’t mind incurring short-term loss will go even lower and drag you down with him.
- While you can make an argument that you will make up lost revenue resulting from lower price with higher quantity, it may not work in the long run.
- Once you accustom your customer to lower price it may become difficult to raise it afterwards. No one likes to pay more for similar products, especially from the same business.
- Finally, it is much more fun to provide higher value, higher quality products and services at higher price than having to compete on lower price. The later requires you to constantly worry about your costs. You do not have much room to have higher cost operations when you are competing on price.
The bottom line is as a small business owner you should focus on differentiating your products and services from competitors rather than trying to beat them on price. Just look at how much fun Apple is having compared to Dell!
Do you agree with our assessment? What is your experience?
