The Danger of Competing on Price

by Victor Cheng

For some odd reason, far too many CEOs have the instinct of cutting price as a way to stimulate sales.

Cutting price is easy to do, but difficult (if not impossible) to sustain as an on-going strategy.

In every market, there is always going to be only ONE lowest-price producer.

There IS an advantage to being the lowest-price producer… just be sure you’re also the lowest-COST producer, too.  Otherwise, you won’t be able to sustain that position for very long.

Strategically, there are only two scenarios that come to mind where this makes sense.

Scenario #1 – The Natural Monopoly – Size Creates Dramatically Lower Cost

In this scenario, two things must be true: 1) the cost structure of your industry is such that the cost of production drops dramatically with increased volume; AND 2) you have a major head start.

This was/is true in many telecommunication industries.  There’s a reason why AT&T became the natural monopoly in the telephone business many years ago.  It is for this same reason that even after the government broke up “Ma Bell” into a bunch of “baby bells” they have all merged back together again.  In that business, size makes a big difference to one’s cost structure.

The idea in this situation is to always be the volume leader in your industry and lowest-cost producer in the industry… which allows you to sustain the lowest prices while still being profitable.

The danger is if you’re in a market where size creates only slightly lower costs, the approach ends up failing.  You can offer the lowest prices, but your costs aren’t much lower… so you end up with the lowest margins.

Scenario #2 – The Network Effect – Size Creates Greater Customer Value

The other scenario where low pricing makes sense is when greater size dramatically increases usefulness to the customer.  eBay is a good example.  It made sense to keep prices low during eBay’s earlier days because the more buyers/sellers that use eBay, the more useful it is to buyers/sellers… which, in turn, attracts more buyers/sellers, which makes it even more useful, etc…

No Points for Being the Second-Lowest Price Provider

If you’re not going to be the lowest priced vendor in your market, you might as well aim to be the highest.  That’s because there’s not much value in being second-lowest.

Here’s a joke:

A guy walks into a bar.  He confidently stands on top of a table and yells out to all the women in the bar, “I’m the second-best lover in the room!”

Of course, the natural response is all the women start looking around, trying to figure out the identity of THE best lover in the room.  No points for second place.

If in doubt, ask K-Mart what it thinks of Wal-mart.

I heard an interesting statistic about K-mart many years ago.  Apparently, 78% of Wal-Mart shoppers drive past a K-mart on their way to Wal-Mart.  If you’re the CEO of K-Mart, how depressing is that?

The Premium Price Provider

If you’re not going to be the lowest price provider, you might as well aim for the upper end of the market.

Marketing guru Seth Godin cites an interesting example of real estate agents.  As you may know, there is enormous pricing pressure in that industry to cut the “standard” 6% commission.  People are cutting that commission from 6%, to 5%, to 4.2%, to 3.3%, etc… His recent blog post suggests that real estate agents are thinking of going the other way.  What if they HAD to charge 7%? What would they do differently to make a 7% commission a good deal for their clients?  (Many random ideas come to mind, including moving services, throwing in luxury spa services as a bonus, or adding a minimum selling price guarantee.)

It’s a very good exercise.  Rather than cut price, add value instead.  Often, the cost of the added value actually costs less than a price drop.

Target does this as a way to stand out against Wal-Mart.  Target definitely has higher prices, but it has nicer, more fashionable, more trendy (well, kind of) clothing than Wal-Mart.  So, it’s cheap (but not lowest cost) chic.

Amazon does this today.

In the early days, Amazon offered the lowest price.  Then they made a big switch that many people missed.  They raised their prices across the board but included free shipping.  So, they went from being a lowest-price provider to most convenient provider… or at least the provider of the greatest instant gratification.  Incidentally, Kinkos did the same thing… they originally led the market as low-price providers, then did a prompt u-turn.  They bumped up prices, became the premium provider, but, in many locations, offered 24/7 retail hours… thus, becoming the most convenient, high-price provider.

So, in your business, you ought to think about what you could do to justify a 20%, 50%, or even 100% increase in prices.  I have done this myself and with numerous clients, all with good results.  Hint: The transition looks much scarier than the reality.

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