ShareThisBy STEPHEN WINDHAUS
It is so common for many start-up companies to take the approach that the best way to beat the competition from the very outset is to establish lower prices for like products and services. Even some established firms have engaged in competitive price wars to secure a marketing advantage, increase cash flow or other financial reason. To the novice entrepreneur that may appear to be very logical, but to the veteran of price wars and long-term profitability it is a double-edged sword that can eventually set you back financially, or even result in a business shutdown.
TRADITIONAL VS. PREDATORY PRICING
In the world of marketing, pricing is typically defined as prestige, customary or discount. Take the example of department stores. High-end pricing can be found in store chains that have fewer outlets and are located in higher-end real estate locations. Some of their items are simply not available in more mainstream locations, but products found elsewhere will likely sell at higher (prestige) prices. The interiors of these stores are luxuriously adorned, and sales clerks dress in rather fashionable clothing. You know when you are in one of these places, and the prices reflect the environment.
Customary and discount pricing are located in department stores that are more numerous and more easily accessible to the mainstream population. Customary prices are what you would describe as the average, or most common sale price for an item.
Discount pricing is best described with one hyphenated word _ Wal-Mart.
Predatory Pricing is a very different world. It can, but does not, exist in all industry segments. It is a strategy whereby one company clearly intends to reduce prices, even below its cost, to drive competitors out of a specific market, to reduce the attractiveness of the market to competitors who may wish to enter it, or to simply increase overall market share. In short, the price is less than the company's cost for that product or service. Each sale results in a loss; not profit.
DRAWING CUSTOMER LOYALTY?
There is absolutely no doubt that all of us look for the "biggest bang for our buck," and unless what you sell is simply a bad product or service, people are going to pay attention. There is no doubt that unit sales and the number of customers can increase but what about customer loyalty? Does this mean the customers will return? They like a bargain, but they also want good customer service and the anticipated quality associated with the product, and they want this consistently. Loyalty equates to repeat business. How long can you continue to sell a product below cost?
COMPETITOR RESPONSE
Predatory pricing is not common among successful companies that have been in business for any extended period of time. They have developed a customer base, loyalty, attention to service and offerings that are in demand for their intended market. Furthermore, they typically endure predatory pricing, even if it results in a temporary decline of sales for that specific product line. Cash reserves are significant to overcome the temporary setback.
Then there is the competitor with healthy cash reserves who is quite prepared to "take you on." This competitor will meet your price reduction, and may even make it harder on you by offering an even lower price.
And this is where I address start-ups. Most of you do not have a lot of cash reserves to take on the established competition. Loyalty and repeat business do not occur overnight. It takes time to nurture the customer, learn what prices the local market can tolerate and what the customers actually want. So don't go into predatory pricing unless you are prepared to wage a war, and risk potential financial crisis. You are more likely to survive by entering the market with customary pricing, provide good customer service and develop a loyal base of repeat business.
(Stephen Windhaus is a small business consultant based in Florida. You can contact him at steve(at)windhaus.com or 772-871-0585. More information and resources about small business and business planning can be viewed at www.windhaus.com.)
