Low prices are no guarantee of profits

Whenever I ask first-time entrepreneurs what's going to make their businesses different from the competition, many of them say, “We're going to be cheaper.”

They think they can succeed with a strategy of undercutting their competition's prices for products or services. Low prices, they assume, will generate sufficient sales to more than make up for smaller profits. “What I lose in margins, I'll make up in volume.”

After all, they see tons of advertisements for big companies that only seem to emphasize low prices. And they know that they comparison shop before they make purchases. So they think that a strategy of low prices is the path to success.

Competing on price is risky. Low prices mean narrow profit margins, and that means less cash. With a small financial cushion, you're vulnerable with every slight increase in costs. The landlord raises your rent 5 percent? That may be your entire year's profit.

That, in turn, means finding ways to reduce costs. The first thing you'll be tempted to do is reduce wages and benefits. Watch out! This means you won't be able to attract good employees. They're less likely to be productive or loyal. You'll be busy keeping an eye on them, and they'll be keeping an eye on the clock.

The next thing you'll do is cut marketing. And businesses that compete on the basis of price almost always depend on high levels of marketing to keep customers coming in the door.

And the customers who do come are fickle. Low-price shoppers are loyal to price. So if the competition decides to squeeze you with even lower prices, your hard-won customers will be gone in an instant.

But while price should never be the cornerstone of your strategy, it also can't be ignored. So how can a small company still maintain competitive pricing?

* Carve out a niche. If you ‘own' a market, you have more room to set prices. If there are 100 mechanics in your city, you'll face constant price competition. But if you're the only mechanic specializing in Volvos, you'll face much less price pressure.

* Work smarter, not cheaper. Improve your profits through innovative practices. Southwest Airlines saved money by using plastic, reusable boarding passes instead of paper passes, and it was the first carrier to use electronic ticketing. Southwest maximizes profits from its planes by getting them back in the air an average of 20 minutes after landing, instead of the two to three hours of other airlines. By being smarter, Southwest became the most consistently profitable airline in the industry.

* Focus on value, not price. Value is a term used to mean the combination of price and quality. When you shop for a winter coat, you may be willing to pay a higher price to get quality that will last many years. Likewise, a client may be willing to pay a higher price for your printing services if you can deliver the job faster with fewer errors than your competition. Excellence and service are competitive advantages that let you justify higher prices.

* Target the right customers. Not all customers are willing to pay more, even for better quality. So make certain you aim your marketing efforts at customers who will respond to the differences you offer and can pay a slightly higher price for that value.

* Build loyalty to you, not your price. Even if you use special pricing (discounts, introductory offers, sales) to initially attract customers, immediately go to work developing relationships that keep customers coming back when the price goes up.

Don't let yourself get caught in a continual battle to be the “low-price leader.” You may win that battle but lose the war — or worse, your business. Remember, you've got a lot more to offer than just a low price.