The Problem With Pricing
To begin with it is more than one problem. Most businesses do not understand pricing and the message that it sends nor do they understand why the customer buys.
The underlying problem is price perception. and not just the customer’s perception of the price but your perception of the price..
Everyone Buys On Value
Everyone buys on value, all the time. A component of value is the price but people do not buy because of price, they buy because of value. Comparing two products or services people will naturally seek the highest value at the lowest price. That does not mean they always by the lowest price, that means they seek the highest value but if all you give them to compare on his price they will always by the lower price.
That is why having a business that is a commodity or is seen as a commodity is always so difficult. If two businesses offer the exact same thing with no other differences consumers will tend to buy the lower-priced. If you are not differentiated and do not know how to demonstrate your value then you will be trapped selling at a lower price than your competitors.
Price informs perception, perception determines value, value drives behaviour
Price isn’t just a number it is a message
- Low price in most people’s minds equates to lower quality
- A higher price often equates to higher quality
- As mentioned before giving discounts trains people to wait until you offer them a discount
Discounting Kills Profits
In the short term , discounting erodes your profit margin when you need it most at the beginning of a new transaction with a prospect.
It you sell a product for $100 that costs you $60 to make and sell that leaves $40 dollars of margin or 40%. (40/100 = .4 or 40%)
When you drop your price by 15% here is what happens. That $100 product now sells for $85 (100 – 15) and still costs you $60 which means you have $25 of gross profit. The margin is now 29% (25/85 = .29 or 29%). And that doesn’t tell the whole story. When you look at cash flow there is another story being told. Undiscounted generate $40 for every sale. Discounted you now generate $25 for resale. You are missing out on $15 from every discounted sale. That translates to 38% decrease in profit to give a 15% discount.
That assumes that a 15% discount is enough to get people to take action. But that is a whole other story discussion.
In the long term, giving discounts to get sales trains your customers to expect lower prices. If you make a consistent practice of this you end up teaching to customers and the market than if they just wait you will drop the price now and in the future.
The more you discount the more your prospective customers will expect you to discount. The more you focus on price the more they will focus on price. You are also signalling to your competitors that you are focused on price and one of two things will happen. They will either also focus on price and start lowering their prices to win back the business. Which will enforce you to lower your prices further. Which creates a vicious cycle or what we like to call it… a race to the bottom.
The other thing that can happen is you focus on price and your competitors focus on value. This means that they will be winning customers and doing so at a higher price which means a higher profit margin for them. Which now means they have more money to spend to get those customers in the first place. And that is a very difficult place for you to compete from when you are simply the low price commodity player.
Pricing is not simple. Pricing is more than a dollar amount, pricing is perception.