When Should You Compete on Price?

ByMatt

It’s interesting to me that for as big a part of business as price and price strategy is, you don’t hear it talked about much. In my MBA program, it was barely mentioned. If you look at the books in the business section at the bookstore, there isn’t a whole section on it. In fact, there isn’t even a “go to” book on price that I saw or have seen recommended.

Considering how much price impacts things in business, I find this kind of surprising. On the one hand, price seems to drive a lot of buying decisions and so would seemingly be something businesses would take very seriously.

On the other hand, I often see people completely out of whack on what they are paying versus what they could be paying, or I think should be paying that I start to second guess myself about if it matters as much as it seems.

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For example, we have a neighbor who literally two days ago was ranting to me about the unfairness of not being allowed to use two coupons at the same time at a local dessert place. One day later, yesterday, she came home with a brand-new car that was two models and ten thousand dollars up from what she had said was “the most she would possibly spend” because the car “drove nice” and had a massage function built into the chairs. Um, OK.

So given the lack of logical world order on this topic, how do you figure out what you should be charging? And is there a time when you should use price as the lure to bring in more business and wrestle sales away from the competition?

Actually, I think there is an answer (or actually, answers) that any business owner can use to figure out if they are on track and when and to what extent they can use price to compete for sales.

How and When to Compete on Price

There is, I believe, a firm answer here.

The right way to know where you should be on price, at a minimum, is by judging your profitability, which includes putting a reasonable value on your own time. The only time you should offer to lower your price below your desired threshold profitability is to get something else valuable in return.

Let’s look at some examples.

Let’s say you’re just starting a business and it’s just you. Suppose you paint houses or build websites or something. You should price your service to compensate you for your time and any materials used. You may decide, in the very beginning, to offer some discounts in exchange for reviews, testimonials, or the practice you’ll get as a result. So you’re still getting something of value, just not directly in the form of money.

Now once you move past the point where it’s just you, usually because your time is now completely used, you have to raise your prices. Why? Because in order to bring on more people to help the business continue to grow, it’s going to cost you more to do the same work you were doing before.

Why? For a few reasons. For one, employees cost more because they require insurance, payroll taxes, benefits (sometimes) and they generally don’t work as hard, fast, or well as the owner and so it takes more of their time to get the same results as the owner got in less time. All of which means to preserve the profit you had before, you need to increase prices to account for the loss in efficiency and added cost of employees.

A lot of new owners don’t realize this and find themselves making quite a bit less as an employer of three to four people and with triple the revenue they had when they worked alone. They often tend to blame other factors but often it’s this simple pricing issue that is at the heart of the problem. The other thing that tends to happen is that now that there is a payroll to meet, in order to keep people busy, owners will underprice some jobs just to keep the staff employed and make sure there is at least enough income to pay the bills and payroll.

This is understandable and a short-term solution, but the right longer-term solution is to make sure the marketing and lead pipeline stays strong and well ahead of the capacity. Even better is to increase prices, so the payroll can be met and if the crew takes a bit longer on each job, doing an even better job, it will result in more referrals and more demand, which lets prices stay high or even increase further.

In other words, as a startup you may briefly agree to discount some work in exchange for credibility building, but after that you can’t really afford to compete on price if you want to maintain your profit (and that’s reason to be in business in the first place) and building a good pipeline of work is the way to be able to maintain and raise prices, which then reinforces your ability to compete on quality and service over price.

On the flip side, if you are continually trying to win business on price by cutting out your profit, in order to stay in business, you will need to rush jobs, cut corners, and shortcut service, which results in bad reviews, fewer referrals and even less business which reinforces your need to further cut prices to keep any work at all coming in.

So aside from an initial price consideration to kick start a business, when else is it OK to compete on price? If you can actually produce an adequate profit and still be the low-price leader.

In this kind of situation, you are either the source of the product or you have a new way of making or doing something that is in fact much less expensive than anything the competition can match.

For example, if a product typically costs $50 to the end consumer, and it costs $10 to make but goes through a distributor and a wholesaler to get there then it will be hard to bring the price down and still have each of those points in the supply chain make any money. But if the manufacturer could sell directly to the consumer, they could sell it for $30 and make more profit than they currently do and still be able to price it way under what it normally goes for. This kind of thing is happening more and more in ecommerce because it is enabling manufacturers to connect directly with consumers and cut out a lot of the middle pieces (think Temu and Alibaba and Shein).

The other way this happens is if a new company comes up with a way to make that $10 product for $1.50. They can now compete on price but still maintain or even exceed the profit margin of the company who can only afford to make it and sell it for $10 to maintain their profit.

So what does all this mean for business owners? It means first, you have to identify what profit you are aiming to make and what your costs are in order to determine your minimum price (note- there is no maximum price! Only a minimum price). Then you have to determine how to get in front of the right consumers who will see the value in what you are offering to be willing to pay that price (or more).

What happens if you are competing against a host of other sellers of something basically identical to what you are offering, and they are selling it at a price that simply isn’t high enough for you to have enough (or any) profit? Well, then unfortunately you don’t have much of a reason to stay in business unless you can change those two things.

You need to either figure out how to differentiate yourself in a way that adds more value in the eyes of your customers, so they are willing to pay more or else you need to find something else to sell. Or you need to be able to cut your costs to be able to make a profit at the prices you are selling at. If you can’t cut costs and you have no other vector to compete on then there isn’t any way to improve or salvage your business. But knowing that is better than not understanding why you are having such a hard time and unable to make it work.

The bottom line IS the bottom line! If you are competing on price but not for either of the two acceptable reasons listed above, then your business is going to have a very hard time providing you the profits it should.

If you’re not competing on price, then congratulations! The next step is to go out and figure out how to sell even more and add more value so you can keep up the good work! 

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