pricing business

Starting A Business ~ The Dangers Of Under Pricing

Most people who run their own business will admit that when they first started out they were pretty clueless and had a lot to learn. This is especially true if you’re setting up a new business in a sector where you have no prior experience. One of the key areas where people often make mistakes is pricing. Pricing your product or service correctly is key to the success or failure of a business. Pricing can be even more tricky in the early days of a business because people are so desperate to gain new customers or clients that they often undersell their services. While marketing strategies such as introductory offers are not always a bad thing, there is a danger that under pricing your services too much could negatively affect your business in the long run. Why?

Credibility

The first problem with under pricing your product or service is that you might lose brand credibility. Have you ever noticed that coffee shops like Starbucks and Costa always seem to be busy, even though their coffee costs more than it might from the cheap cafe around the corner? Have you also noticed that branded soft drinks like Coca-Cola and Pepsi are two of the best selling soft drinks on the market, even though cheaper branded soft drinks are sold right next to them on the shelves for up to a quarter of the price? This is because the majority of people are willing to pay a premium for a quality product. Sometimes lowering prices can do more to harm the credibility of your service or product than help it.

You Need To Make Money

When I first started out in business a friend of mine gave me some great advice. He said that in business you compete in one of two areas, you either compete on price or you compete on service. If you choose to compete on price then you’ll always be busy, but the chances are you’ll be a busy fool because you won’t be making much money.

To illustrate let’s pretend I’m a hairdresser and the going rate for a haircut is £10, I open a salon and decide to win business from my rivals by charging £5 per cut, due to my cheap prices I get a lot of people through the door and I start cutting hair. By the end of a long 15 hour day I’ve managed to cut the hair of 40 different people and have made £200! After deducting my salon costs this profit reduces to £150 so I’ve made £10 per hour but hold on a minute, I was being paid £12 an hour to work for someone else!

My business rival around the corner charges £10 per cut and has only cut the hair of 25 people today, ha ha. When I think about it though he has made £250 today and has only worked a 10 hour day. After deducting his salon costs of £50 he’s made £200, £20 an hour!

It’s all well and good winning lots of business by undercutting your rivals but if you have to work every hour under the sun to maintain those contracts and still don’t make any more money than you would in an employed position then what’s the point? You might as well get a job and enjoy the benefits that steady employment can bring.

It’s Not Easy To Raise Prices

Another problem with under pricing your product or service is that customers and clients become used to paying a certain price for it. It’s not always easy to raise prices at a later date without hurting or even losing your business.

Somethings Got To Give  

It’s almost impossible to compete on both price and service. If your going to supply a cheap product or service then something inevitably has to give. Often the sacrifice is the quality of your product or service. Think back to our hairdresser rushing to cut the hair of as many people as possible and tired from working such long hours, surely the quality would suffer.

Find Other Ways To Add Value

There will always be someone out there who will try to undercut your prices, let them get on with it. I’m not saying you shouldn’t find innovative ways to give better value to your customers, but don’t get dragged into a price war. Take pride in your product or service and do your best to stay competitive on price, if you value your business offering then others will too.

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11 Responses to Starting A Business ~ The Dangers Of Under Pricing

  1. I under priced when I first started to run my ecommerce business. It was a bad idea. I would get orders, but I would lose money on every one. Not a good business model. I quickly learned.
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  2. Someone we know is a hairdresser in her home and charges less than the shops and she has a steady flow. One service she provides is far cheaper than at the shops but she’s a pro at it and fast. $21 vs her $3.00 charge but again she’s been doing it since she was young. That being said, she also gets to cook, clean, mind the kids, answer the phone, do whatever else she would have to do if she was out working for someone else. No clothes to buy, no petrol to drive to work, no bagged lunch, no babysitter. I guess the benefits to her are much greater to stay home. When I asked her why her price was so cheap she simply said, they are very overpriced in the salon what she does. AH, well, she’s been doing it for a few years now and says she won’t be working for anyone but herself.I can understand though the value of making sure your prices are competitive but not undervalued.
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    • I wanted to avoid saying you should never compete on price in the post because it is possible to run a business like that, I just think it’s important to think about the implications of doing so before you start. Personally with a $21 charge vs a $3 charge I think she could charge more. She could make more money for doing less work and still the price would be more than reasonable. If she charged $6 she would only have to treat half the clients for the same profit and still be around 70% cheaper than the salons but then I’d still be advocating under pricing :-).

  3. Jose says:

    One other factor you need to consider when pricing goods or services is your overhead. If you are a brick and mortar you have a lot less leeway in how you price. If your working from home on ecommerce or a service business you have a lot more flexibility. You still don’t want to price to low or risk losing credibility.

    • I agree Jose e-commerce is a different ball game and price is likely a big issue, though not every online retailer can be the cheapest so I’m guessing they find other ways to compete.

  4. Matt says:

    “In business you compete in one of two areas, you either compete on price or you compete on service.”
    Very good advice, I think I fell victim to the underpricing when I was a self employed sound engineer. As I’m thinking of resurrecting that on the side, I’ll definitely be looking more towards the service side.
    I think marketing has a lot to do with it as well.
    If you price yourself at the going rate, there’s a 50/50 chance potential new customers will choose between yourself and the competition, so you should still get business, but if you market yourself well, at least more people will know about you, or have a more informed opinion about you.
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    • I agree Matt, good marketing is essential to any business and it’s an area that’s also affected by pricing. I’ve known a lot of people who have set up in business and spent large amounts on marketing, vehicles, sign writing etc. but then don’t charge enough for their services. They then get a few years down the line and find they’re not making enough money to maintain or replace their equipment and can’t afford to keep up their marketing campaigns.

  5. It can be difficult for smaller stores to compete with the bigger ones who run at much smaller profit margins due to the quantity of stock that they move.
    Still I agree, undercutting is a poor business idea.
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  6. Mochimac says:

    As a freelancer who sells her brain as a consultant, the danger of underpricing can also make you not an eligible candidate.

    I’ve heard from a number of people who screen for consultants that if they ask for anything below a minimum for a good consultant, they know it’s a trick and they’re just there to get the money for 2 weeks and will ruin the reputation of the third-party company.

    Your minimum is a true minimum for what you are worth in services. If you don’t charge it, people won’t (psychologically) put any value on what you do.

    Even if they see someone cheaper for half the price, they might think: Well they’re cheaper, I can find 2 guys like that!

    …but then everything ends up being half-assed or badly done, and by the time they call me in to fix their mess, they’re paying 3X as much to redo everything.

    It’s much easier to start from scratch with a good person than to try and fix the crap of 3 cheap folks.

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