Should you cut your prices or change the game?

pricing strategy
10% price cut = 38% profit cut

This article looks at a pricing strategy for your business. It’ll be of interest to you if you tried cutting your prices and got burnt or are tempted to cut your prices to drum up more business.

Pricing Strategy

There are a zillion pricing strategies and there is 1 big red hole that most businesses have fallen down at some point.

That’s the big red hole of cutting your price to try to keep up with or sell more than your competitor.

Fact: the price cutting strategy to generate extra sales is mostly a race to get to the bottom first. You’re likely competing with other businesses who are unaware of the impact of price cuts on their own margins, unaware of the self-inflicted damage being done.

The common mistake associated with price cutting is a very big one. The mistake is to assume that by cutting prices by 10% you just need to do 10% more business or 10% more volume to make up for the loss.

No, because when you cut your price you unleash this lot:

  • demand increases to the point where you can’t keep up
  • delivery and product quality fall
  • profitability takes a nose dive.

You’ll never be able to beat a price-cutting business which doesn’t understand this because they are going broke themselves. You’re not competing against a worthy competitor – you’ve just joined them in a nose dive.

The Profit

The key to understanding all of this is the profit you are making.

It’s about the size of that gap between your selling price and the cost to you of making that product or delivering that service.

That gap is really important but more often than not gets forgotten because of:

  • insecurity about the value of your product (is it really worth this much?) or
  • pressure of an experienced pushy buyer (I can get it cheaper down the road!).

When we let our own insecurity or somebody else’s pressure allow us to view price as the only game in town we pay dearly. We always pay when we don’t understand pricing psychology.

Pricing Psychology

Misunderstanding pricing psychology and buyer psychology is what causes businesses to fall into the red hole.

Think about this. What if pricing really was the only thing that buyers considered when looking at your product?

If price was the only factor buyers considered there would be only 1 supplier of every product or service you can think of – the cheapest supplier. This would apply to the shirt on your back and the house you live in.

Open your eyes. It’s highly unlikely you’re wearing the cheapest shirt on the market or living in the cheapest bricks and mortar you could find. There were other considerations when you chose what to wear and where to live.

We’ll come to those other considerations but for now let’s understand with cash numbers how cutting your price plays out.

Pricing & Profitability

So what’s the real cost to you of cutting your prices by say 10%?

Simple example:

Selling Price 135
Let’s say you sell your widgetything for 135 shekels based on a cost of supply of 100 shekels. You make 35 shekels on each sale.

Price cut 10%
What happens when you try to stimulate demand or keep up with your competitor by cutting your price by 10%.

You’re now selling your widgetything for 121.5 shekels and your cost of supply is still 100 shekels. That means your profit on each one has now fallen to 21.5 shekels.

But, more importantly, your 10% price cut has had a massive slash at your profits. Here are the numbers:

21.5/35 = 0.6143 = 61.43%

That means a 10% price cut meant you just cut your profits by 38.57% (100 minus 61.43). That’s a much deeper cut than most businesses imagine it to be.

Ouch. That’s self-inflicted misery.

So how do you achieve higher profit margins, avoid price wars and still be in healthy profit?

You have to win or close your sales at full price, full fee or full rate. To do that you have to make some changes.

Let’s repeat that – it’s important:

You have to win or close your sales at full price, full fee or full rate. To do that you have to make some changes.

Change the Frame Around Your Product

To maintain your price in the face of competition or to raise your margins for higher profitability you need to change the frame of reference for your product or service. You need to change how buyers view and appreciate your product.

To do this you make your buyer aware of how you deal with those things that could really keep them up at night if they make the mistake of going with your lower-priced competition….

We’re talking about your competitive advantage:

Delivery – tell them how long it takes to fulfill orders or get the product to them, or what’s special / better about the way you do that.

Quality – if you have a safer crash helmet then say it. If your product is clearly the best fit for where your client is now, then say it. If you have proper quality control in place then explain it.

Service – explain how your level of customer service is leagues ahead of cutprice.com.

Process – explain how easy it is to do business with you. Think convenience, think location, think  ….

Everybody remembers these things when it’s time to commit or sign on the dotted line. The key is to communicate them early enough in the buying process so that it’s your dotted line that gets signed on 🙂 Your website content is a good place to start.

Pricing Strategy & Competitive Advantage – Summary

You should understand by now how price is rarely the most important deciding factor in buying decisions (look at your own shirt again).

You should also understand the damage to your profitability of even modest price cuts.

Finally, you should understand that there is another way to compete and win better quality business. You need to speak about quality, service, process, delivery and the factors unique to you and your business that are important to your customer.

Author: Mike Odlin 

(If you’ve already tried competing on price you can contact Mike here.)