Price is frequently regarded as something that has to be minimised. Entrepreneurs, and small business owners in particular, often see low pricing as the key to delivering acceptable value to customers and being competitive in the marketplace.
It’s thanks to such a view that price basically becomes a source of guilt. Yet the truth is that almost all companies fail to maximise the role price has to play in driving success and sustainability – and many, in doing so, endanger their futures.
Underpricing is the problem I encounter most when I’m training, mentoring or coaching early-stage businesses, a huge number of which misguidedly believe their focus should be on doing things cheaply rather than doing things better.
This ethos is usually due to a lack of confidence in a value proposition, or a fear of not having enough sales and throughput to meet overheads and fixed costs. Both are rooted in defective reasoning.
Let’s briefly examine each of these mindsets before exploring the unsound mental processes that give rise to them. You may wish to ask yourself if any of what follows echoes your own approach to pricing.
Lack of confidence
There are several reasons why a company might have scant confidence in its value proposition. The most common are disappointment at not winning business and customer complaints over expense.
The former is a classic illustration of how the past can cloud subsequent decisions. Failing to win business can fuel a conviction that low pricing is the only recourse when it comes to “sweetening the deal” and ensuring sales – which is most certainly not the case.
Meanwhile, customer griping over pricing is essentially a fact of life. We might even say it’s just natural. It’s vital to remember in the face of such rancour that feedback is invariably context-specific.
Many customers have discovered asking for price discounts really does work. That’s why there can be something of a game to be played. As I’m fond of saying though, the easiest way to introduce a discount is to first introduce a rise.
Ultimately, we shouldn’t forget what a value proposition is. It’s an encapsulation of what customers value about a company. It’s a crystallisation of what differentiates a business from the competition. It covers much more than price, including crucial dimensions such as trust.
Fear of insufficient sales
This is a phenomenon that stems from a desperation to generate enough sales to cover costs. In tandem, it can be traced to an associated belief in a rational market and an assumption that a lower price will inevitably draw more customers.
As it happens, the customers who help a company grow are seldom seduced by cheapness. They’re more likely to be sceptical about low-priced offerings and instead attracted by interesting features and unique selling points.
It’s the customers who simply buy whatever they deem cheap at any given juncture who thwart a company’s efforts to grow. Their “bottom-feeding” approach means they can’t be relied on, because they’re inherently disloyal.
Any company that cuts its prices in desperation is essentially banking on people using perfect information to make perfect decisions. It supposes the world is inhabited by machine-like beings powered by pure logic.
As a wealth of behavioural and psychological research has demonstrated, there’s no such world. On the whole, this is good news – because irrationality can bring significant business opportunities.
The root of the problem: cognitive bias
So exactly why do so many entrepreneurs and small business owners fall victim to these misconceptions? In most instances the answer lies in cognitive bias – systematic flaws in how information is processed, interpreted and used to make judgements.
Confirmation bias is notably rife. It occurs when individuals or organisations zero in on information sources and data that echo what they already believe – reinforcing their existing opinions and thereby diminishing the likelihood of arriving at considered, evidence-based decisions.
Anchoring is also widespread. It arises when an initial piece of information is treated as disproportionately important, effectively “anchoring” everything that follows. Many negotiations are shaped by this bias.
There’s also availability bias. This describes the inclination to rely excessively on whatever information is at hand rather than seeking a statistically instructive array of data. Again, this is likely to lead to decisions that don’t take full account of all the relevant facts.
These biases can be part of the emotional baggage we all carry around with us. They might be a manifestation of naivety or inexperience. They may even be an upshot of our evolutionary history – an innate aid to making decisions with speed. Whatever their origins, they routinely go unrecognised – sometimes with dire consequences.
Price as an engine of enhancement and expansion
Most new companies fold within three years. Issues around profit margins and cash flows are usually among the contributing factors. Even for those fledging enterprises that stagger on, low prices and the limited margins they produce can stifle growth.
As a result, many small businesses stay small. Their erroneous attitudes towards pricing – underpinned by cognitive bias – suffocate their potential and undermine their sustainability.
The reality is that underpricing is rarely an engine of value and competitiveness. It prevents reinvestment in product development. It discourages innovation. It dashes hopes of superior employee training and higher salaries. It makes achieving goals such as reducing staff turnover and creating a happier, more skilled, more efficient workplace much harder, if not impossible.
At least for a well-run company, the act of instead raising prices isn’t about profiteering – a practice that’s neither laudable nor conducive to long-term success. It’s about enhancing prospects and enabling expansion.
That’s why entrepreneurs and small business owners should stop regarding price as something to be minimised. The entire concept is fallacious. Clear, unbiased thinking should reveal price not as a source of guilt but as a fundamental means of making a company better for all its stakeholders.
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.