One of the biggest hurdles for new businesses is pricing: there’s a constant fear of setting higher prices than competing products, because people might not buy. This tends to result in super low pricing strategies. But selling cheap isn’t the best approach, and may just be delaying the inevitable:

 

Cost-based pricing versus value-based pricing

There are two basic ways to price your product or service. The first approach is cost-based pricing. Using this method, the product is priced according to the norms set by competitors, or a price index. Contrary to what many new business owners think, cost-based pricing is rare in consumer retail. Cost-based pricing is most often used for commodities, such as crude oil, coal, gold, and rubber. This is because there are few ways to differentiate these commodities (one company’s crude oil is the same as another), and the prices are highly transparent (there are well regulated, global indexes which chart commodity prices). The second approach is value-based pricing. This method sets prices based on the perceived value of a product or service. This method is more common, and more practical, for consumer retail. Value-based pricing is the reason why one company can sell handbags for $50, and another can sell them for $15,000. It’s not about the inherent value of a product, but about how much you can make people think the product is worth. Publilius Syrus, a Roman writer, was one of the first people in recorded history to describe value-based pricing. He summarised it by writing: “everything is worth what its purchaser will pay for it”. That may sound like common sense, but it describes a profound understanding of pricing strategy. It means we shouldn’t try to price based on inherent value, but on what our target market is willing to pay. For example, water has a much higher inherent value than diamonds, but we all know which one costs more.

 

Why shouldn’t you try to sell cheap?

There are four main reasons why selling cheap is a bad idea:

  • The market will always want more for less
  • Selling cheap can mean a worse product
  • Lower prices don’t always lead to more sales
  • Most SMEs don’t have the infrastructure to sell cheap

 

  1. The market will always want more for less

There’s always someone who can go cheaper than you. If your product’s sole advantage is its low cost (see point 2), then your only alternative is to go even cheaper. If it turns out the competitor undercutting you is a major corporation, then you will probably go broke before they do. If the competitor is another small business, then the two of you will probably go broke together. Over time, the market will continue to demand more for less, until it breaks your business. If you price your goods against the cheapest on the market, there’s almost no chance you will ever get to raise your prices – every year, new entrants with the same idea will come in with equal or lower prices, and keep you “locked down”.

 

  1. Selling cheap can mean a worse product

A classic example of the “sell cheap” error the Nano, from Tata Motors. The Nano was marketed as the world’s cheapest car, priced at around SGD $2,340(!) The expectation was that, due to the low price, millions of people who couldn’t afford regular cars would flock to buy it. The problem was, the Nano faced a lot of quality cuts to make that price. There was no air-conditioning, some parts of the car were glued on, seats were unadjustable, and nobody could forgive the 33 horsepower engine. The end result was a flop. This is a huge issue with selling cheap – once you go this route, you often find yourself cost-cutting, and removing extra features from your product or service. There’s a grain of truth in the saying “cheap isn’t good”, and this is where it comes from: when you want to undercut the competition, it often shows up in the quality of your work. This leads to lower sales despite your pricing (see point 3), and stigmatises your brand. Once you’re known as a purveyor of cheap junk, it’s expensive to turn your reputation around.

 

  1. Lower prices don’t always lead to more sales

Some items will show the same volume of sales, despite big changes in price. An example of this would be niche products, such as parts for vintage cars. For niche products, sales volumes are mainly affected by the number of potential customers, not so much the price. Even if a business were to decrease the price of vintage car parts, for example, it’s unlikely that sales volumes will skyrocket: there just aren’t that many people with a 1937 Aston Martin. One of the worst mistakes a new business can make is to enter a niche market, lower its prices, and then wonder why it’s not profitable (even as it steals customers from other specialist shops). Another factor to consider is the issue in point 2. If the low price makes your product so, well, lousy that no one wants to buy it, sales won’t improve either. For example, you probably could cobble together cheap plywood furniture, and sell it for $10 to $20. But if it looks awful and falls apart in a year, you can bet most people will just go to IKEA instead.

 

  1. Most SMEs don’t have the infrastructure to sell cheap

Despite all we’ve said, it’s not impossible to compete on the basis of low prices. Several large businesses have done it well, for many years. But therein lies the reason for their success: they are large companies. A large corporation is better able to undercut competitors, as they buy in so much volume that suppliers are happy to give steep discounts. But a small business doesn’t have that kind of leverage. There’s zero chance that your small cafe can try to undercut, say, McDonald’s and still be profitable (at least, not with legal meat sources). With regard to services, you have to consider if you have the means to cope with volume. For example, say you provide web design services, and you halve your prices. The next week, five more customers come to your door. That’s well and good, but do you have time and manpower to service the greater volume of clients? If you don’t, then all you’ve done is agree to damage your reputation (when you fail to deliver), for a tiny profit margin.

 

But how can you raise your prices?

There are many ways to implement value-based pricing, that even small businesses can do. We’ll describe this in our next article, on how to make people click “buy” in seven steps. In the meantime, talk to our business solutions experts, on tools to improve your margins. Synagie can help you to lower logistical costs, and take your business digital; both are better alternatives to playing the discount game.

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Olive is the Co-founder and Managing Director of highly scalable Synagie.com. Olive is a total geek and loves all things technology, and is an awesome mumpreneur to two lovely baby girls. Olive's mission is to help brands get into the online commerce space and has achieved to date, close to 200 brands and counting!

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