The following article was written by Tuck Aikin several decades ago about what would-be entrepreneurs fail to understand about pricing that can doom them out of the gate. Even though it is several decades old and some examples are dated, the lesson about pricing is as true today as it was then. I hope you enjoy it.
“And I can do it a lot cheaper than anyone else…” he said triumphantly, obviously proud of his ability to trump soon-to-be competitors. “Those guys are just ripping people off. I don’t see how they continue to get away with that.” he continued self-righteously. This was in response to our question about what principal competitive strategy the aspiring new business founder planned for his enterprise.
Certainly, price competition is a valid competitive technique, but it’s only one of many. Nevertheless, the great majority of would-be entrepreneurs seem to choose price competition in an almost knee-jerk fashion as their sole strategy to enter the marketplace and sustain their business. This simplistic approach, probably more clearly than any other, demonstrates the lack of business knowledge and marketplace savvy that is at the core of far too many business failures.
For some reason, those who have never been business owners believe that all that’s needed for business success is to “build a cheaper mousetrap” and that hordes of customers and untold riches will follow automatically. If only it were that simple!
Price is a rather complex strategic tool. Set it below your product costs, presuming you know what they are, and you’ll go out of business sooner or later. “We’ll make it up on volume” suggests you can lower your per-unit cost with increased volume, but in the real business world, that rarely happens.
Colorado Springs Western Pacific Airlines is a classic example. Remember the overflowing airport parking lots, the traffic jams, and the chock-full luggage kiosks? Where are they now? Sure, Western Pacific’s bargain basement prices attracted traveling customers by the sardine can full, but the volume still wasn’t enough to cover the costs of their unfilled seats, so the result was inevitable: bankruptcy.
After realizing their mistake, could a price increase have saved them? Probably not because all those travelers who drove here from the south end of Denver would then have been able to take comparably priced flights from Denver International airport – a lot more convenient location.
So, what about setting your prices at the high end of the scale? Often that’s entirely appropriate if your product or service is targeted at the luxury end of the market, but get too proud of your high quality or service, and prospective customers you are trying to attract will stay away in droves!
The high-end limit, then, is almost never set by your costs. It’s set by the perceptions of prospective buyers – is the quality, availability, convenience, and uniqueness worth the price? You’ll find out soon enough, just as the Natural Wonders Inc. company finally discovered. The high pricing of their telescopes, coffee table quality books, and other educational retail store products was obviously out of balance with their rather exclusive market’s demand, so they had to shutter all 286 stores nationwide.
Could they have lowered their prices to save the company? That’s doubtful. They probably relied rather heavily on repeat business and no one wants to find out that something they just bought for $120 is now priced at a “normal” $90 at the same store as their original purchase! The perception of being overcharged for something creates a lasting impression that’s far stronger than the reaction of seeing a previous “deal” for a product or service subsequently priced more in line with generally prevailing prices.
It is clear, then, that pricing is much more of an art than it is a science. It relies heavily on a thorough knowledge, a good “feel” or “seat-of-the-pants” understanding of customers’ perceptions about related quality, service, availability, and of competitive alternatives. Unfortunately, that’s called business experience, the very thing a first-time business owner doesn’t have! So, there’s the dilemma: price too high and you’re out of business; price too low and you’re out of business. What to do?
Probably the best strategy is to set initial prices at or slightly below those of your closest competitors and try to attract customers through superior responsive service, expanded store hours, greater choice, and convenient location. Your competitors already know the ropes, so why not take a tip from them? Then later, when the price/demand relationship and your true costs are better known, modify your pricing, but remember – dramatic price changes may signal something to your customers you don’t want.
A big price decrease is often interpreted to mean your business is in trouble, or that you’ve been overcharging, that you’re greedy. A big price increase can signal that you don’t know what you’re doing and that you’re desperate. That too, makes customers wary. So, proceed with caution, or you’ll pay the price.
Tuck Aikin was a former SCORE colleague of mine for many years until his retirement. Tuck is a prolific writer and wrote small business-themed articles for the Colorado Springs Gazette for many years. As a co-mentor, Tuck was my inspiration for me starting this blog. The preceding post is reproduced with permission from the author.
