The only true way to define market price is that it is what someone is prepared to pay.
One of the first questions any startup faces is: “how much should I charge for my product or service?” and one of the first things an investor typically doesnot want to hear is that your business’s main differentiator is that it’s cheap.
Yet that’s a surprisingly common strategy for novice entrepreneurs to put forward. They believe that, just by being cheaper than the other guys, they will generate sufficient sales volumes to compensate for lower profits.
The strategy can work — if you’re Walmart and can squeeze cost out of the supply chain feeding you — but for the rest of us, pricing low involves a lot of risk. Low prices mean low profit margins, less cash in your business and so you’re going to be vulnerable to any cost increases that get dumped on you. Even something as simple as your office rent going up at the end of the year could wipe you out.
Don’t be cheap
Cheap pricing often leads to a cheap attitude towards staff as there simply isn’t a lot of cash to pay them. In turn that creates low morale, low productivity and low loyalty … which means more management effort to make sure they are doing what they are paid them to do and a more strained working environment.
With no cash cushion to absorb unexpected costs passed on to a business, the next temptation will be to reduce marketing expenditure. Yet that’s what drives customers to deliver the volume … but if you’ve set out your stall to say you’re cheap you are inviting your customers to be loyal to your price and nothing else about you. If a larger competitor decides to start a price war, they can wipe you out by taking their prices below the level at which you can afford to stay in business and your customers won’t give a damn.
For all these reasons, competing on price alone is rarely a great strategy for a start-up. Far better to make yourself a niche where you are a specialist. If there are 100 grocery stores in a city, price competition is inevitable. But if yours is the only organic food specialist, the pressure on price will be much lower.
Think smart, not cheap
The trick is to think smart, not cheap and to focus on delivering something customers really value, not the lowest price. Used in this sense, value is a combination of quality and price and is often about the way you do what you do, not what it is. Speed, excellence and great service can create barriers to competitors that also justify higher prices.
If you’re going to do that, you need customers who are willing to pay more to reflect the value you are delivering. So you need to target them rather than the folk who are just interested in low prices and build their loyalty to you. You might still use pricing stunts like discounts, sales and introductory offers to get them through the door the first time but after that you need to find a way to build a conversation and a relationship with them that will keep them coming back even when the price they pay goes back up to the normal level. They need to be saying to themselves (and their friends) “These guys are worth the extra because …”
The flip side of that is that, unless some of your customers are actually walking away complaining your product or service is over-priced, it’s probably under-priced. Don’t be afraid to lose the customers who just want to buy cheap-cheap. Unless you really have the scale to play the volume game, they are never going to make you money.