The following blog post was written by Kevin McCarte, a Springboard Graduate Assistant with the MBA program.
Focus on yourself. Small business owners get so caught up in the moment that they don’t stop to think about their pricing and whether or not the price they are setting is correct. Sure, the Wal-Mart’s of he world thrive on the prices they charge to their customers, and the competition may sell a similar product at a lower price. However, using a successful company as a benchmark and simply copying their strategies will not always produce the results small businesses want to achieve.
Cost is the primary factor that companies should consider in order to determine what price they should charge the customer. In a successful, established manufacturing company where all jobs are customizable, pricing will depend on a number of factors: how loyal a customer is to the company, the sales volume, the application for the product, and the target price they have in mind. All of these factors should be considered, but cost is paramount. If a company cannot cover its costs with a healthy profit margin, it will likely shut down.
Consider the economic principle of sticky prices. Once a customer and a business agree to a price, barring a chock to the market, why would that price ever change? Surely as a business becomes more efficient and individual costs for production decrease, the customer will not be informed. It would be foolish on the business’ part to inform the customer that the product they are selling became more profitable, but small business owners never seem to consider the inverse. Once the business and the customer agree to a price, it creates expectations in a customer’s mind, dangerous expectations that can destroy a company. As a business, stealing customers through price manipulation can only last for so long. The customer will expect the business to continues to offer better-than-Wal-Mart pricing, when Wal-Mart already has razor thin margins. All things equal, if prices rise, customers will simply move back to Wal-Mart. A majority of businesses would not be able to survive competing on price alone with Wal-Mart, since economies of scale exist. Not only can Wal-Mart sell the product at a lower price because of its size and volume, but it can also offer those prices because the cost for production on all of its products is also lower than what a small business can produce. Competing on price alone is not a viable option in the business world.
Instead of focusing on what the competition is charging for its product, small business owner should focus on what they can provide their customers. Small businesses have the opportunity to negotiate all prices, since each customer is special and unique to them, while large, established companies have rigid pricing structures and bureaucracy to work through to give customers what they need. Since every customer is unique to them they are able to customize a solution faster and with a higher service level than larger companies. In the dynamic world of business, a fast, customized, and accurate solution can be worth more to customers than simply setting a low price. Every company has different profit margins they can operate with and using the price set by anther company can be a critical mistake. It is important to know what the competition offers, but merely setting your price based on a competitor’s price can be a death sentence. What if they are not adequately covering their costs? Appealing to a customer’s pocketbook may be the easiest way to steal business from the competition, but is it really worth it? Business owners often feel that profit can be made up solely by increasing the volume of sales, but that may intensify a problem.
Pricing for any start-up business is a crucial part of the future success of a company, however, it is not the only part. One of the most common mistakes a small business owner can make is to believe that the price of their product is going to make or break the company. In fact, customer loyalty is based on perceived value of the product offered. A superior product with higher value will always beat an inferior product. It may be easy to look at another company and attribute their success to their pricing strategies, however, the value behind the pricing is what’s important. If your products are priced higher than your competition, be sure to effectively communicate the reasons why through marketing materials.