How Cheap is Cheap?

As a marketer I have found that many businesses operate under the delusion that they can be successful by selling their products or services at the cheapest price. It has become almost universally acceptable that this pricing strategy will only work for large companies who dominate a marketplace. If you think about this, it does make sense. These companies call the shots. They typically create demand. They possess some proprietary product, specialized service or technology that allows them to establish the market value of any particular product or service. As such they set the acceptable consumer price and ultimately capture the largest segment of the market. Think about the airline industry or Intel or in the past, Big Mama Bell.

What I find most fascinating is when applying this universal economic principal to some industries, the opposite seems to be true. In many industries it is the smaller players that seem to be focusing most on low cost solutions. It is my hope that some of these marketers can begin to recognize that there is a better strategy than merely offering a low cost option. My intent is NOT to suggest collusion or price fixing in any way. It is to demonstrate that there is high profit potential for small businesses that differentiate their products and then price accordingly.

Let’s look at some examples of what typically happens to businesses when they attempt to meet the challenge of establishing competitive pricing models.

The owner of an exclusive clothing salon was experiencing a financial crisis. Even though sales were brisk, and many of the prominent men in the community were frequenting his shop, the business was not profitable. When the owner asked his local banker for advice, he was told to lower his prices to stimulate sales, and the helpful banker lent him more money. After two more loans and two more price reductions, the business defaulted. At the time that he closed the business, he was charging prices that earned him minimum wage to create exclusive creations, one of which was worn to a presidential inauguration!

Another retailer was puzzled by the fact that his interim reports always showed a profit, while his annual tax return showed huge losses. Initially, this business owner thought that his C.P.A. was helping him by saving money on taxes. What was really happening, however, was that his C.P.A. used an estimate of 50 percent for cost of goods sold (or a 100 percent mark up which he had suggested in the past). In reality, the retailer was afraid of price competition and was only marking up 33 percent, so his cost of goods were actually 75 percent of sales. Naturally, the annual audit for tax purposes reflected reality. The owner (who had opened a second location) thought that he had been borrowing money to expand his business, but the increased loans were used to cover operating losses.

Why do so many business owners confuse low pricing with proper pricing? One reason is that some owners actually believe the: “I can do it cheaper” precept. This may be true under the best of economic conditions. With the best deals from suppliers, the best terms, the highest level of sales, the most experienced staff, the most vibrant economy and so on. But in reality no business can plan to operate under the best of circumstances at all times. There are simply too many variables that are out of our control. And unfortunately consumers have memories like elephants. Once you lower your price it is very difficult to raise it again. You set your own market value and have to live with the consequences.

Perhaps another reason for this confusion is simply that fact that low prices often work well for big businesses, and a distinction is not made between big and small businesses. However, we have all seen small retailers go out of business after trying to compete with Wal-Mart or Kmart on price. Harvard’s Professor Michael Porter, author of Competitive Strategy, tells us “The presence of economies of scale always leads to a cost advantage for the large-scale firm … over small-scale firms.”

So what can the small to mid-size business owner do in lieu of offering a lower price?

Offer something different. Differentiate your product by quality, design, or brand, and charge a slightly higher price. Offer a sharper focus. Be a specialist who focuses on one segment of the market and caters exclusively to it. Focus on branding. Branding is not merely for the BIG players. Entrepreneurs and small business owners can also differentiate themselves with a unique branding strategy. In fact it is even MORE important for smaller organizations to set themselves apart, particularly if they are competing with the BIG GUYS! Remember, your customer’s perceptions of WHO you are is all the matters to them. Often times your reputation is wrapped up in what advertising guru, Bill Bernbach called the Unique Selling Proposition (USP). What sets you apart from the crowd? What do you do that no one else does? This is far more important than the price of your product or service. Everything that we do or say both internally and externally should revolve around this.

Smart pricing is good for the small business owner, large dominant businesses and for the industry as a whole. But it’s especially good for the consumer because they are ensured a product or service that is built around providing quality and performance rather than meeting a perceived market price.

In this economy so many consumers are having reservations about getting a good value on whatever product or service they are buying. We owe it to them and to ourselves to prove that our solutions really are better than ever. That today’s solutions are in fact revolutionary! Let’s act like it, rather than trying to beat the guy next door out of a dime. If we act like we are offering a cheap solution, then consumers will believe that we have a cheap solution. And we will all be facing the same problem of: how really cheap is cheap?

Posted in Pricing Strategies, Uncategorized.

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