The hidden cost of underpricing: why your business deserves more

In this fourth of five articles, David Falzani explores how underpricing can sabotage SME growth and profitability, and why it’s crucial to value your offering correctly.

For many small and medium-sized enterprises (SMEs), pricing can feel like a tightrope walk. You want to stay competitive, but you also need to generate enough revenue to cover your costs, grow, and thrive. Unfortunately, many SMEs fall into the trap of underpricing their products or services. While it might seem like a smart strategy to attract customers and secure sales, underpricing can do more harm than good in the long run.

There are several reasons why underpricing is a persistent issue among SMEs. Sometimes, business owners lack true confidence in their value proposition, which leads them to believe they need to keep prices low to stay afloat. They might fear that a higher price will scare away customers, particularly in competitive markets where price sensitivity is perceived as high. Another common reason is that business owners may set their prices once and rarely revisit them. The idea that pricing is a one-time decision, rather than a dynamic process, leaves money on the table and stifles growth.

I have found underpricing is one of the most common and dangerous mistakes businesses make. Underpricing not only undermines profitability but also impacts the long-term sustainability of a business. For SMEs, which often operate with tighter margins than larger corporations, getting pricing right is critical to ensuring survival and growth.

1. Eroding profit margins

Underpricing directly impacts profit margins. Every dollar left on the table when you could have charged more is money that could have been reinvested in your business. Lower margins mean fewer resources for marketing, research and development, staff training, and overall growth initiatives. Many companies believe they can "fix" profitability problems further down the line by cutting costs, but the reality is that without healthy margins upfront, these efforts rarely succeed. You need profits from sales to drive reinvestment and growth.

2. Undervaluing your offering

Price isn’t just a number—it sends a strong signal about the value of your product or service. By setting prices too low, you may inadvertently communicate to customers that your offering is worth less than it truly is. As a result, customers may associate a lower price with lower quality, even if your product or service outperforms the competition.

A well-known example of this is the Apple iPhone, which commands premium pricing despite fierce competition in the smartphone market. Apple’s pricing strategy reflects its confidence in its value proposition, and customers are willing to pay more because they perceive superior quality, design, and innovation. Similarly, SMEs that price themselves too low miss the opportunity to position themselves as premium providers in their markets, with the premium profits this would provide.

3. Attracting the wrong customers

Under-pricing often attracts price-sensitive customers who are less likely to be loyal and more likely to jump ship when a competitor offers a lower price. These "bottom feeders," tend to be more demanding, less profitable, and ultimately more costly to serve. Instead of focusing on price-sensitive customers, SMEs should aim to attract premium customers who are willing to pay more for quality, service, and unique value propositions.

4. Stunting growth potential

Perhaps the most damaging consequence of underpricing is the way it stunts your business’s growth potential. Without sufficient profits, you won’t have the capital to invest in growth initiatives like expanding your product line, entering new markets, or upgrading your infrastructure. Researching my book, I found successful high-growth companies often charge premium prices, which allow them to reinvest in their businesses and achieve sustainable growth. SMEs that stick with underpricing often remain small, missing out on the opportunity to scale up and expand.

One of the primary reasons SMEs underprice is a lack of confidence in their value proposition. Your value proposition is essentially the thing  that you do that your customers find valuable enough to pay for. It’s not just about the functional benefits of your product or service but also about the emotional and psychological factors that influence customer decisions.

For instance, Daniel Kahneman’s work on behavioural economics, particularly in Thinking Fast and Slow, shows how customers often make decisions based on irrational factors, such as emotional attachment or perceived status. Understanding these dynamics can help SMEs refine their value proposition and price accordingly.

When you’re confident in the unique value you provide, you’re less likely to underprice. Instead, you can position your offering as a premium product or service, which attracts the right customers and supports sustainable growth.

Now that we’ve explored the dangers of underpricing, how can SMEs avoid this trap? Here are a few strategies:

1. Revisit your pricing regularly 

Pricing shouldn’t be a one-time decision. I recommend that businesses revisit their pricing regularly, ideally at least once a year or even quarterly. This allows you to adjust for changes in the market, shifts in customer demand, and fluctuations in costs. Regular pricing reviews ensure you stay competitive without leaving money on the table.

2. Conduct market experiments

I also advocate conducting safe market experiments to test higher price points. For example, if you’re expanding into a new geographic area or launching a new product line, consider setting higher prices to gauge customer response. These low risk experiments can be game changing. Many businesses are surprised to find that their conversion rates remain the same, even with significantly higher prices, resulting in a substantial increase in profitability. The same is even true for slightly lower sales – the profits are still much higher.

3. Focus on value-based pricing

Instead of relying on cost-plus pricing, which simply adds a markup to your costs, consider value-based pricing. This approach sets prices based on the perceived value of your product or service to the customer. By aligning your pricing with the benefits your customers receive, you can charge more and increase profitability without sacrificing sales. Another advantage of value based pricing is that it provides you with a compelling sales narrative – how and why you create value for your customer.

4. Educate your customers

Finally, don’t be afraid to educate your customers about the value you offer. If your prices are higher than the competition, explain why. Whether it’s superior quality, better customer service, or added convenience, customers are often willing to pay more when they understand the full range of benefits they’re receiving.

Underpricing might seem like a safe strategy in the short term, but the hidden costs can quickly outweigh any initial gains. By undervaluing your offering, eroding your profit margins, and attracting the wrong customers, you risk stifling the long-term growth and success of your business. Instead, take the time to revisit your pricing regularly, focus on value-based pricing, and conduct market experiments to ensure your prices reflect the true worth of your product or service. In doing so, you’ll not only boost profitability but also position your SME for sustained growth and success.

Winning Sales & Marketing Book 2024 in the Business Book Awards with “Double Your Price: The Strategy and Tactics of Smart Pricing” Professor David Falzani MBE has trained over 2,000 growth companies at the University of Oxford, Royal Academy of Engineering, and Nottingham University, leveraging his experiences as an entrepreneur and business consultant.