April 2020 issue
Some of you may have noticed that the economy doesn't seem to be doing well lately. Don't be needlessly fearful! Times of transition can be painful, but they can be times of great opportunity.
When was the last time you thought about your firm's pricing strategy?
Have you ever thought about your firm's pricing strategy?
Pricing Question from a Reader
I live in a low cost area, but my freelance business competes with companies in New York City and London. Many of my potential clients argue that I should reduce my rates because I live in a low cost area. Are they right?
You're hardly the first person who has been told to drop his rate because he lives in a low cost area.
Today we'll explore some of the reasons why this view persists and examine a few ways in which you can respond to such outcries from your shoppers.
Before we dive in, it would be helpful to understand why so many people take a supplier's location into account when considering how much they are willing to pay.
- The cost that a vendor must bear to service a customer is a price floor. Most business owners don't like to sell their wares for less than they cost to render. Doing so causes them to lose money.
- The maximum price that customers are willing to pay acts as a price ceiling. Business owners who attempt to sell products at prices above this ceiling will make no sales.
The price floor and the price ceiling define the range of prices that can persist in a marketplace over the long term.
- A firm in an expensive city would be required to earn higher revenues in order to pay for its higher costs. Those that were unable to do so would exit the market, further increasing the pricing power of the remaining vendors.
- Similarly, some shoppers in high-cost areas would earn relatively high wages and be able to spend more for a given service.
For most of human history, service providers had to be located within a close proximity of their buyers. This requirement is constantly being loosened. Due to a combination of technological innovation and shifting mindsets, many vendors are now beginning to break the chains of geographic dependence. Unfortunately, a strong grasp of economic principles has not yet taken root among the masses. Many buyers are still using the mental shortcut that worked so well in the past: they attempt to derive fair pricing from the specifics of the vendor's geographic location.
Their line of thinking is likely supported by early experiences with outsourcing. Far too often, firms in low-cost areas competed on price rather than quality. As a result, many buyers were taught to expect a strong correlation between vendor quality and areas that featured a high cost of living areas.
Now that we've taken a look at the problem, let's consider how vendors like you can respond.
- Acceptance - The most straightforward option is to accept the fact that you'll be paid less due to your location. If you're desperate for work, and you're seen as a commodity, you'll find yourself trapped in a vicious cycle of competing on price.
- Avoidance - Some business owners sidestep the issue entirely through a combination of trickery and deceit. Either by setting up the appearance of corporate headquarters in expensive locales, scrubbing references to their true locations, or hiding behind third parties. While many businesses have found success through these methods, I would caution against them. Even a hint of deliberate omission or duplicity has the potential to damage one of the most valuable commodities in the world of business: customer trust.
- Mitigation - Many vendors in low-cost areas utter the same refrain, "it's not fair." It's not fair that they are being penalized for living where they do. This statement is tantamount to an admission of defeat. More than that, it's completely unnecessary. There are three straight-forward approaches that vendors can use when a potential buyer brings up the geographic pricing argument.
- Refusal - Vendors always have the option of saying, "No." Holding steady on price is one thing, but buyers may be more willing to consider your point of view if a reason is provided. It may soften the blow to explain that you need to keep your schedule open for more lucrative contracts in your pipeline or to afford the resources that would be required for the requested work package. That said, this approach may risk alienating hesitant buyers. As a result, it may not be appropriate for vendors who are desperate for income.
- Education - Rather than rejecting a buyer's logic, it might be worth demonstrating the implications of his reasoning. Try explaining to him that you're actually considering a move to a far more expensive area; thus he'll have to increase his willingness to spend. When the buyer objects, claiming that your expenses have nothing to do with the value that you provide, agree with him and offer up your original rate.
- Enlightened Self-Interest - As in most negotiations, enlightened self-interest usually proves the most effective approach. Ask the buyer point-blank, "If you spent more time to find someone who is as competent as I am in a more expensive place, and wound up paying him the rate that I've requested, how would you be better off?" This question will highlight the fact that search costs are never zero and the primary driver of value is the output of labor rather than its location.
- The best option - Of course, the ideal solution to almost every business problem is to be so desirable (and dare I say it, premium in nature) that customers never focus upon your price in the first place. Buyers will be far more interested in your availability and level of interest than the dollars that you charge or the town in which you hang your hat.
Many buyers have a geographic mindset when it comes to pricing. Countering this mode of thought isn't easy, but it can be done. All it takes is a plan, a bit of practice, and the ability to risk saying "No."
Questions come from readers like you. If you'd like your questions answered, send them my way.
Pricing in the News
- eBay bans sale of masks and hand sanitizer over gouging concerns - High prices are a hard sell, but those items are an impossible sell
- Coronavirus price drop: Break out the bib, lobster selling at bargain prices - Business owners usually hate bottom feeders, but they taste great with melted butter
- Ticket sellers tell Congress they'd support federal mandate to disclose all fees up front - Ticket vendors for athletic events might be good sports and play ball with regulators instead of throwing customers a curve ball
- 'I canceled my membership' - customer backlash after Lyft hikes Bay Area bikeshare prices - Bike sharing company tries to break cycle of losses, but will it backpedal after spinning its wheels?
- Shopper uncovers 'misleading' Aldi price hike - Using fake historical prices should be ancient history
- Men who hoarded over 17,000 hand sanitizer bottles donate stockpile amid price-gouging probe - Men who tried to price gouge hand sanitizer decide to wash their hands of the business and keep their noses clean
- Danish store instills pricing trick to stop hand sanitizer hoarders - Pricing trick works like magic
- Oil price collapses to lowest level for 18 years - Traders are burning the midnight oil, but prices are slipping faster than greased lightning
- The Wild Hunt for 100-Ounce Gold Bars - The one thing that isn't worth its weight in gold is gold
From the Blog Archives
- Amazon and a Pricing Power Conspiracy Theory - Sometimes strategy can be hidden in plain sight
Notable Pricing Quote
"A laugh, if purchased at the expense of propriety, costs too much." -- Quintilian
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