Competitive Pricing Strategy for Profit Maximisation
A critical element of business success is developing your pricing strategy.
Developing pricing strategy in competitive situations is something most business owners have to do. Business owners are faced with two opposing forces: lower prices generally make it easier to sell, but lowering prices also lowers the profit on each sale. Most business owners strive to maximise sales. However, this is often not the best strategy for a small to medium size enterprise. The key is to maximise the profit from the total sales volume we achieve. This needs careful analysis.
Low Price Strategy
A very common pricing strategy is to keep prices low to undercut our competitors. We want to keep our prices as high as possible, but beneath our competitors’ pricing levels. Usually we only contemplate dropping our prices in response to a competitor dropping their prices. However, this pricing strategy may be detrimental to business success. When you drop prices, you obviously have to sell more volume to make the same profit. This may not be so easy.
What does this table tell us? For a business achieving a gross profit of 50%, a 10% reduction in prices would mean that sales would need to increase by 25% to achieve the same profit. If your current profit margin is lower than 50% then you would need to increase sales volume by even greater amounts to achieve the same profit.
This scenario suggests to me that even if your competitor starts a price cutting war, you would be far better off to hold the line with your current pricing level to minimise your losses, if you do nothing else. It is far more likely that you will lose fewer sales than you would need to gain if you try to match your competitor’s price cuts.
Low pricing strategy is only one side of the story. What you need to consider is whether there are other areas in which you can compete, that makes pricing strategy less important. What if you could improve some aspect of the service or delivery of your product that increased the perceived value of your offering without significantly increasing the cost? Wouldn’t that make your product more desirable? What if you could communicate your increased value better to your customers? This strategy is called a positioning strategy, because it positions your product in the perception of your market in a different space than the low price products.
With a positioning strategy based on higher perceived value, your pricing strategy can be somewhat different. Low price is no longer the reason you make sales. What would happen if you actually increase your prices? Let’s consider the downside first. How many sales could you afford to lose before your overall profit slipped below your current levels? Again, the answer depends upon your current margins and the amount of your price increase. A business operating on a 50% profit margin could raise its prices by 20% and afford to lose 29% of its sales before profit would be reduced. This information should indicate that a pricing strategy that positions your product at a higher level than your competitors is likely to be much more profitable, as you would have to do a lot wrong to lose that many sales, just as a result of increasing your prices.
Higher Profit Pricing Strategy
The critical issue here is: how price sensitive is your market? If you can develop some elements into your competitive strategy and marketing communications that can reduce the emphasis on price in the buying decision, then the rewards from adopting a premium pricing strategy can obviously be quite significant. Most customers do not buy merely on price. Instead, they buy on the value of the product and service bundle they receive by dealing with you. This could include extra guarantees or faster delivery or any number of other aspects that add value to the purchase. Customers that want you to compete on the basis of price alone are better left to your competitors to deal with. In my experience, they are never worth the effort. They will bargain your price down, cutting your profit margin. Then they will want the earth, trying to extract everything they can from you before they pay for the work. They will complain about the slightest thing that goes wrong. They will call you back to fix things when there is nothing wrong. Who needs customers like that? If you are making a reasonable profit on each sale, you can afford to be selective. You deserve customers who value the extra effort and value you provide. They know that it is going to be of benefit to them and they are prepared to pay for that extra additional value.
You are far better off and will make more profit by learning to sell the extra value of your offer than to cave in on price and merely compete at that level. Low price strategy will only work if you have a clear cost advantage over your competitors. If you are not sure that is the case, improve the marketing and selling skills in your organisation so that you can sell more at higher prices. That is how the most successful companies do it.