The pricing strategy of a small business can ultimately determine its fate. Small business owners can ensure profitability and longevity by paying close attention to their pricing strategy.
Commonly, in business plans I’ve reviewed, the pricing strategy has been to be the lowest price provider in the market. This approach comes from taking a superficial view of competitors and assuming one can win business by having the lowest price.
Avoiding the Lowest Price Strategy
Having the lowest price is not a strong position for small business. Larger competitors with deep pockets and the ability to have lower operating costs will destroy any small business trying to compete on price alone. Avoiding the low price strategy starts with looking at the demand in the market by examining three factors:
1. COMPETITIVE ANALYSIS: Don’t just look at your competitor’s pricing. Look at the whole package they offer. Are they serving price-conscious consumers or the affluent group? What are the value-added services, if any?
2. CEILING PRICE: The ceiling price is the highest price the market will bear. Survey experts and customers to determine pricing limits. The highest price in the market may not be the ceiling price.
3. PRICE ELASTICITY: If the demand for your product or service is less elastic, you can then have a higher ceiling on prices. Low elastic demand depends on limited competitors, buyer’s perception of quality, and consumers not habituated to looking for the lowest price in your industry.
Once you understand the demand structure in your industry, review your costs and profit goals as set in your business plan or financials. The low price strategy is best avoided by small business, but there are conditions such as a price war that can drag a company into the lowest price battle.
Evading a Price War
A price war can wreak havoc in any industry and leave many businesses out of business. In the early 90’s, I observed the competitive exercise equipment market enter a price war in a large city market. Profits were plentiful, but a price war took the gross margins from 42% to 12%. In less than 18 months, over 60% of the retailers were out of business, while my division went national. Take these tips to evade a deadly price war:
∙ ENHANCE EXCLUSIVITY: Products or services that are exclusive to your business provide protection from falling prices.
∙ DROP HIGH MAINTENANCE GOODS: There may be products or services in your business that have high customer service and maintenance costs. Drop the unprofitable lines and find out what customers don’t want.
∙ VALUE-ADDED: Find value your business can add to stand out in the marketplace. Be the most unique business in the category.
∙ BRANDING: Develop your brand name in the market. Brand name businesses can always stand strong in a price war.
Leave the price-cutting and price wars to big business. Small businesses with solid pricing strategies can escape a price war and low price position. Carefully consider your price decisions. Your business depends on it.