Beating Competitors with Price Cuts

July 2018

Howdy pricers!

Hopefully everyone had a happy and safe 4th of July. You do know what happened on July 4, 1776, right?

American independence began!

Or maybe not.

It turns out that America actually declared independence on July 2, 1776. For nearly a quarter of a millennium, we've been celebrating one of the nation's most beloved holidays on the wrong day!

If you've been so mislead about American history, shouldn't you be concerned about potential misconceptions regarding your organization's pricing strategy? Sometimes you just don't know what you just don't know.

Pricing Question from a Reader

I'm a manager at a small company. My firm's competition has been getting fiercer every year, so we've been forced to start cutting corners on quality just to compete. How do we know when we've reached a price that's low enough so that we can stop trying to cut further?

Thanks for the great question!

For all intents and purposes, the point at which those competing on price get to a level that is low enough is when the final price reaches zero.

There's almost always someone who is willing to cut more corners, can achieve greater economies of scale, and is willing to subsidize production in the short term. Even if you don't have such a player in your market now, it will only be a matter of time until such a competitor appears.

I'm willing to bet that your firm's executives might not be willing to reduce their pricing to zero, so let's take a step back and consider your situation.

You didn't mention your market, but I have a hard time believing that every one of your industry's customers isn't willing to pay more than the absolute minimum for whatever it is that you produce. Yes, every market has cheapskates, but most markets have a sizable number of customers who are willing to spend more money in exchange for more desirable offerings.

Whether we're talking about salt, watches, or even video games, a subset of customers can be counted upon to open up their wallets and make it rain for upscale providers. I diagrammed this fact in my recent article entitled I Can Not Bear "What the Market Will Bear."

Many producers have been conditioned to see the world as a red ocean environment in which competition is viscious and increases in intensity each and every year. They've been trained to believe that markets become more efficient over time and margins should be expected to trend toward zero. As Amazon CEO Jeff Bezos famously remarked, "Your margin is my opportunity."

I think vendors are far too fixated on competing on price. Companies like Unilever have demonstrated that, yes, firms can make money by taking strong brands and continuously cutting corners and lowering the level of value that they deliver, but is that really the type of business that would deliver even the smallest semblance of pride to its owners, employees, or customers? More importantly, is that really the type of business that earns customer loyalty or can compete against an upstart who is willing to part with his offerings for even less?

By devaluing their products and releasing lesser versions of their previous offerings, firms destroy their potential for pricing power and their ability to capture the interest of the customers who are willing to pay the most. Even when corner-cutting is eliminated, a sustained marketing focus upon low pricing sends a clear and powerful message to potential buyers: neither quality nor utility is particularly important. In other words, a low price is a public admission that the product being sold is a mere commodity, no better (and likely worse) than those sold by any other vendor. In the case of a pure commodity, one would have every right to expect consumers to put price first and foremost in their purchase-making process. Fortunately there are relatively few pure commodities in this world.

Some people think that the best way to win a price war is to stand firm and refuse to play. I think it's even better to move in the opposite direction. Consider raising prices and modifying your products so that they are, in some way, superior or more desirable than those that have been offered in the past. Such moves may appear risky in the short term - and they are. Nevertheless, a race to the bottom transcends risk entirely; it's an almost certain trip to financial ruin.

Rolex's executives don't go into conniptions when they see coupons for Casio's watches. Ferrari's management team doesn't fret when Kia announces big rebate programs. Broadway producers probably don't even notice when movie theaters offer matinee pricing for their blockbuster films.

Doubling down on a premium status will eliminate large swaths of one's competition overnight. The vast majority of your current competitors won't be able to follow your lead because they're far too weak to resist the allure of another round of price cuts and product devaluations. It's like the law of the hammer: when all you have is a hammer, everything looks like a nail. In the world of business, if all your competitors know is how to cut prices and reduce quality, well... it isn't hard to predict what they're going to do.

Of course, moving upscale isn't a panacea, but low-pricing tactics should be left to those best equipped to offer them: mass-market vendors and high school students looking to earn gas money for their time. Most small and mid-sized companies would be better served by putting their money in a savings account than selling commodities at rock-bottom prices.

Interestingly enough, despite all his bluster to the contrary, Jeff Bezos might actually agree with me. A few months ago, Amazon announced a pricing increase for Amazon Prime. This, despite the fact that Walmart now offers two-day shipping for free. Maybe Mr. Bezos really meant to say that "your lack of margin is my opportunity." While competitors are fighting on the floor for scraps, they often forget to look for the better cuts of steak on the table.

Questions come from readers like you. If you'd like your questions answered, send them my way.

♫This Q&A and many others are now available on the Pricing After Dark podcast.

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