Issues around profit margins and cash flows are normally among the major contributing factors when a new business collapses. Little wonder, then, that underpricing is the number-one problem I come across when training, mentoring or coaching early-stage companies. If this is you, then you need to develop a smart pricing strategy.
In my experience, price is frequently viewed as something that must be minimised. Entrepreneurs and small business owners in particular see low pricing as the key to delivering acceptable customer value and being competitive in the marketplace.
Price thus becomes a source of guilt for many companies. This is quite wrong. The reality is that almost all businesses neglect to appreciate – and therefore neglect to maximise – the enormous role price has to play in achieving success and sustainability.
Broadly speaking, this is because they think their focus should be on doing things cheaply. In fact, their focus should be on doing things better – and underpricing can be a serious impediment to accomplishing that vital goal.
In this article, I outline the mindsets that give rise to so much erroneous thinking around pricing. You may wish to consider whether you recognise aspects of your own approach in what follows.
Are you confident in your value proposition?
One of the most common reasons why a company might favour low pricing is a lack of confidence in its value proposition. This is often the result of a failure to win business.
Such a disappointment can easily fuel a conviction that underpricing is the best option when it comes to ensuring sales. Yet this is just a classic case of the past unnecessarily clouding future decisions.
Confidence can also be shaken by customer complaints over expense. Such gripes are basically a fact of life, not least because many customers have learnt asking for price discounts really does work.
It’s important to remember in such instances that feedback is always context-specific and that sometimes, sure enough, there’s a game to be played. It’s also worth remembering that the easiest way to introduce a discount is to first introduce a rise.
Maybe above all, it’s important to remember what a value proposition is: an encapsulation of what customers value about a company. Ultimately, it should encompass much more than price – including crucial dimensions such as trust.
Are you afraid of insufficient sales?
Another reason why a company might fall into the trap of underpricing is fear of not generating enough sales to cover costs. This links to a misguided belief in a rational market and an assumption that a lower price is guaranteed to attract more customers.
The truth is that the customers who help a company grow are very rarely lured by cheapness. They’re more likely to be sceptical about low-priced offerings and instead drawn by striking features and unique selling points.
Of course, there are customers who habitually buy whatever happens to be cheap at any given juncture. But these “bottom-feeders” are liable to harm a business’s attempts to expand, as their proven disloyalty makes them innately unreliable.
Moreover, the notion that every consumer makes purchasing decisions exclusively on the basis of pure logic is dangerously mistaken. As a wealth of behavioural and psychological research has shown, the idea of a rational market is poppycock.
This is good news for anyone in business, at least on balance, because irrationality gives rise to opportunity. Pricing would be a very curious affair indeed in a completely rational world.
Understanding the curse of cognitive bias
So why are so many entrepreneurs and small business owners vulnerable to these misconceptions? This brings us to cognitive bias – systematic failings in how people process and interpret information.
Confirmation bias is especially widespread. It arises when individuals or organisations prefer information that echoes what they already believe, thereby reinforcing their existing opinions and undermining their capacity to arrive at evidence-based decisions.
Anchoring is also rife, most notably in negotiations. It occurs when an initial piece of information or data is treated as disproportionately significant, in effect “anchoring” everything that follows.
There’s also availability bias, which entails relying excessively on whatever information is at hand rather than seeking a statistically instructive variety of inputs. Again, the likely outcome is a decision ignorant of all the relevant facts.
These biases can stem from inexperience or naivety. They may be part of our emotional baggage or just a kind of inbuilt aid to making swift judgements. Whatever their cause, they repeatedly go unacknowledged – sometimes with disastrous consequences.
Why it makes more sense to raise prices
Low prices and the meagre margins to which they lend themselves destroy many new businesses. They also keep thousands of other companies small by suffocating potential and chipping away at sustainability.
This is likely to remain the status quo until more entrepreneurs and small business owners rethink their approach. They need to understand underpricing is very seldom an engine of value and competitiveness.
Ideally, a company should be able to reinvest in product development and innovation. It should be able to provide its employees with excellent training and high salaries. It should be able to reduce staff turnover and create a more satisfied, more skilled, and more efficient workplace.
Underpricing doesn’t help meet any of these objectives. It’s usually possible to enhance a business’s prospects and enable expansion only if prices are instead raised.
The knee-jerk reaction may be to think of this as mere profiteering. This taps back into the concept of price as a source of guilt. But the lesson of clear, unbiased thinking is that price is actually a fundamental means of making a company better for all its stakeholders.
Develop a Smart Pricing Strategy
If you are a start-up or indeed any business struggling with establishing a clear path to bring your products to market at the right price, then my new book linked below can help. An integral aspect of developing a clear business plan is to thoroughly understand the intricacies of smart pricing strategies. Here I guide you through the essential principles of pricing and demonstrate how even minor adjustments can significantly affect a business’s success. For entrepreneurs, this book is an indispensable resource in making informed decisions about pricing and maximizing profitability.
David Falzani MBE is a Professor at Nottingham University Business School’s Haydn Green Institute for Innovation and Entrepreneurship (HGIIE) and president of the Sainsbury Management Fellowship. This article draws on his new book, ‘Double Your Price: The Strategy and Tactics of Smart Pricing’, published by FT Publishing.
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Nottingham University Business School specialises in developing leadership potential, encouraging innovation and enterprise, and developing a global outlook in its students, partners, and faculty. It is recognised as one of the world’s top business schools for integrating responsible and sustainable business issues into its undergraduate, MBA, MSc, PhD, and executive programmes and has unrivalled global reach through Nottingham’s campuses in the UK, China, and Malaysia. The School holds a Small Business Charter Award in recognition of its important role in supporting small and medium enterprises. It is accredited by both the Association of MBAs (AMBA) and the European Quality Improvement System (EQUIS) and ranks among the UK’s top ten for research power.