How to Compete Against Low Price Competition
One of the most frequent complaints I hear from business owners and sales people is that their competitors always seem to be cutting prices and that makes it difficult to sell their goods or services at a reasonable price where they can make a profit. While this problem appears to be common, in my experience the most successful businesses do not suffer from this complaint.
In fact, the most profitable businesses usually sell at higher prices than their competitors. It is tempting to drop your prices to compete against low price competition. Sometimes the pressure does not come from competitors. Often our customers pressure us to reduce our prices.
No matter where the pressure comes from, it is important to realise what effect price cutting has on your profit before you go ahead and reduce your price. Let’s use a simple example to illustrate the impact of price cutting.
If we currently sell a product for $100 with a profit margin of 50% (cost $50, profit $50) and we sell ten of these per week, we will end up with a profit of $500 at the end of the week (100 x 50% x 10 = 500).
Still with me? What would happen if we reduce our price by 20%? Our price would reduce to $80, which means our profit on each sale would reduce to $30. Therefore, to achieve our same weekly profit of $500 we would have to sell seventeen items (500 / 30 = 16.666).
Wow! In some situations that would mean getting seven extra customers, or 70% more traffic through your store, or 70% more inquiries. I don’t know about you, but that seems like a tough ask to me.
If you want to see what the impact is with your profit margin and some more price change scenarios, we have some tables in an article called “Competitive Pricing Strategies” on our website. You can read it here www.progressivebusinesssolutions.co. nz/competitive_pricing.htm.
Let’s look at what would happen if you didn’t drop your price. How many sales do you think you would lose? That’s hard to predict, but you would need to weigh up whether the profit you might lose on lost sales would be more or less than the profit you might not get if you didn’t get seven extra customers (or the equivalent sales increases).
What about increasing your prices? Let’s use the same scenario and look at what happens if we increase prices by 20%. How many sales could we afford to lose and still make the same profit? If our price increased to $120 we now make $70 per sale. We would make $490 profit with only seven sales. We could actually afford to make 29% less sales to make the same profit as when our profit margin was 50%.
Would you lose 30% of sales if you increased you prices by 20%? It really depends on how price sensitive your market is and how good you are at selling. Just imagine if you only lost 10% of your sales, you would make 9 sales at $70 profit, an increase of $130 or a 26% increase in profit over all.
For most businesses, I expect that resisting the pressure to reduce price would result in higher profit than they would achieve by price cutting. Another way to look at it is to increase your profits, you could probably afford to increase your prices quite a bit before you would start losing too much business. At least you would probably be making the same profit without working so hard at it. That sounds quite appealing to me. How about you?