by Freddy J. Nager, Founder of Atomic Tango LLC + Survivor of Multiple Recessions; photo by Ed Yourdon via Wikimedia Commons…
When the economy is singing the hardcore blues — kind of like now — many businesses are tempted to lower their prices.
But lowering prices creates three problems:
- It sends the message that you’ve been ripping off your customers all this time.
- It means you’ll have difficulty increasing your prices to “normal levels” when the economy starts jamming again.
- It kills your profit margins, so you won’t have the cash to do what might really make a difference during a recession: better marketing.
Rather than lower your prices, offer lower priced alternatives. For example, back in 2003, Nike snapped up Converse for $305 million. Now why would the galaxy’s leading athletic shoe company spend all that money for another? One word: Target.
Nike refused to sell its shoes in Target, fearing that its presence in a big-box retailer might damage its brand. But Converse, which had a lower price point to begin with? No problema.
In fact, Converse sold so well at Target and other retailers, Nike essentially made back its entire investment in a year. According to Nikebiz.com, “Since acquiring Converse in 2003, revenue has grown at a compound rate of 22 percent, and in fiscal 2007 Converse revenues grew over 20 percent to surpass $550 million.”
Nike thus taps both ends of the price spectrum without lowering its image through discounting, while consumers can save a few bucks without feeling that they traded too far down in status. And now that consumers’ wallets are feeling much lighter, there may be many more Converse sales in the immediate future — not a bad gift for Converse’s 100th birthday.
Just Don’t Do it
Even when the economy is humming along, a low price strategy is not the smartest option. Here are 6 reasons:
1. Don’t forget the “price = quality” perception
Customers equate high prices with high quality and low prices with low quality, even in business-to-business services. Along the same lines, “price = prestige.” Everyone loves a bargain, but status-conscious consumers don’t want to be seen shopping in a discount store or using a discount product. If you choose to go the low price route, make sure to convey the product’s quality.
2. There can only be one “low-price leader” per industry
Either you’re the cheapest in the market, or you’re just another cheap offering. If you decide to be the absolute cheapest in the market, your operations must be uniquely structured to reduce costs and — this is critical — to ensure that no one can copy or beat your prices.
Walmart is the low-price leader in most markets because it uses its unrivaled size to extract the lowest prices from its suppliers, it uses technology to reduce labor requirements, it minimizes overhead (very little advertising, for example), and it pays lower wages than its unionized competitors.
Even with those supporting processes in place, the low price strategy does create problems: Walmart’s low wages, for example, have come under attack from critics. Likewise, Dell was the low-priced leader in the PC market — until its competitors found even lower-cost ways to make computers. Now Dell is struggling to find a position.
3. The stock market does not like low prices
Stock investors like two things: growth and profits. Low-price leaders, by definition, have very thin profit margins, which makes them very unappealing. They can grow fast, but then they plateau since they don’t have the profits or brand flexibility to extend into other markets. To mollify their investors, they are then forced to give away some of their profits as dividends, which leaves them with even fewer resources to invest in development.
4. You are stuck in your position
If you position yourself as a low-price leader, it’s nearly impossible to change that position. After finding its stock price had flat-lined, Walmart tried to reposition itself as “fashionable,” but it was too late. Consumers see Walmart as cheap and will not buy “fashion” from it. Clothes, yes. Fashions? Not so much.
Dell had made computers a low-priced commodity, which was very appealing for cash-strapped corporations and consumers during an earlier recession. But as soon as the economy recovered, consumers wanted more sophisticated products, and Apple was there waiting for them. Apple then enjoyed tremendous growth, both in profits and in stock price, which gave it the cash to invest in other areas, such as the iPhone. Dell might still sell more computers overall, but its low-price policy does not generate the resources or reputation to enter the world of sophisticated electronics. (Where is Dell’s phone or MP3 player?) Perhaps Dell’s fortunes will turn up as the nation’s economy turns down again — but with all the low-priced players on the market (Asus, Compaq, Acer, HP), the bottom of the industry has become a very crowded place.
5. A wealthier competitor can price you out of existence
If you are a young company and try to steal market share by using low prices, bigger companies with deeper pockets can lower their prices even more to drive you out of business. They can afford to lose money for a long time, while most startups cannot afford to lose money at all. While “predatory pricing” is illegal in many areas, your powerful competitors will happily pay the penalty after you’ve gone out of business. The lesson? Don’t start a price war unless you’re absolutely sure you can survive it!
6. You will deny yourself necessary capital to build your business
Low prices means you won’t have money to compete. Consider all the following:
- How will consumers learn about you? You don’t have money for high quality advertising, so you will have to resort to cheaper quality ads (such as flyers) that hurt your brand and attract unprofitable customers.
- You cannot afford a nice location in a high-traffic area.
- You cannot provide the service that today’s selective consumers demand, particularly if you decide to be a low-price high-volume business (too many customers, not enough high-quality workers to serve them).
- You cannot afford to pay high salaries, so unless you’re a 100% family-run business, you won’t attract the best talent, and your higher-paying competitors will lure away your best employees.
- If there is a disaster or a prolonged recession, you will not have the cash or insurance to survive.
- You cannot invest in the latest technology.
- Finally, most investors will not be interested in a low-margin business with a weak brand, so if worse comes to worse, you won’t be able to sell your business.
As marketers, your strategy should be to create large profit margins and a powerful, flexible brand that attracts customers regardless of your pricing (think Apple). Yes, that requires more planning and strategy than simply underpricing the competition.
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