“It is unwise to pay too much, but it’s worse to pay too little. When you pay too much, you lose a little money. When you pay too little, you sometimes lose everything, because the thing you bought was incapable of doing the thing it was bought to do. The common law of business balance prohibits paying a little and getting a lot — it can’t be done.
If you deal with the lowest bidder, it is well to add something for the risk you run. And if you do that, you will have enough to pay for something better.” — John Ruskin (1819-1900)
Symptoms of Pricing Problems
You know you have a pricing problem when:
1. Sales incentives or compensation is based on sales rather than profit margin. A sales rep can hurt profits while giving in on price and not be penalized significantly for doing so.
2. Your costs of goods are rising as a percent of total sales. Your margins are eroding.
3. You are making price changes across the board. We saw this with the run-up in gas prices and airlines and package delivery companies adding fuel surcharges.
4. You are using cost-plus pricing.
Different Ways to Think About Price
• It’s what you think your product is worth to a particular consumer at a particular point in time.
• It’s the customer’s least favorite part of buying.
• It’s a marketing expense to you, the seller.
• It’s the only marketing tool that directly affects both the top and bottom lines of your profit and loss statement.
• It’s the easiest marketing tool for your competition to copy.
• It’s a marketing tool that represents everything about your product – especially affecting quality and value perceptions.
• Price + Perception = Value. Value is what consumers want.
Why Cutting Price to Gain Sales or Share Does Not Work
There are several pricing models. One thing they all have in common is that they show you will have to lose a lot more market share by not reducing your price, or by raising your price, than you will make up for in lost margin, or gain in added margin.
Here’s a simple mathematical example:
Let’s assume you’re selling a widget for $100 and making 10 percent ($10) and you decide to reduce your price to meet your competition to $95. All of a sudden, you’ve reduced your margin to five percent ($5) – a 50 percent reduction in margin!
You will have to more than double your market share, or sales, to make up for what you’ve just given up in margin. I know of very few price inelastic industries where this is an effective strategy.
Think very long and hard before you ever reduce the price of your product or service.
I urge clients to determine the highest price they can charge and still make the sale. This requires knowing your customers and knowing your competition. It’s also very helpful to know what your customers think of your competition — that’s where the consumer insights come in.