Raising prices when your business is doing well is easy. But during slow times, how much should you charge your customers?
Over the years of coaching small business owners, I have seen many intelligent business leaders willing to cut prices to attract new clients eagerly. This might seem to work at first. However, the hidden disadvantages of discounts can really hurt your business in the long run.
The Disadvantages of Discounts
It often seems like discounts are the no-brainer way to bring in more sales or keep customers coming back. Actually, the opposite may be true.
1. The perception of your business’s quality suffers.
It’s straightforward – we all expect higher quality products and services to cost more. Think about prestigious brands like Mercedes Benz, Louis Vuitton, and Tiffany.
Just like those big-name brands, your pricing should be aspirational. One of the disadvantages of discounts is that price reductions actually devalue your brand image. Instead of bolstering confidence in your business, you’re inviting customers to have a lack of confidence in your offerings. This sets a dangerous precedent.
2. Dropping your prices can lead to a price war.
Another one of the major disadvantages of discounts is that it prompts customers to compare prices. When you discount your products or services, you are forced to compete with bigger companies with a lower cost structure than a small business owner. Whichever price you set, someone can always do it cheaper. A simple internet search will lead your customers to many options, some of which might be cheaper than what you’re offering.
You can’t win this game against a bigger competitor for long, and you will probably be undercut at some point again. It’s a malicious cycle that you should avoid. This kind of price war makes it very difficult to stay the leader.
3. Dropping your prices kills your profit margins.
Here is an example of one of the key disadvantages of discounts. If you have a 50% gross margin and cut your price by 20%, you have to increase sales by 67% to keep your starting profit margin. It’s pretty rare to see a sales spike that will offset a margin hit like that. To calculate the cost of price discounts in your business, try my easy to use grid.
The only way to hold your profit margin is to reduce your cost of goods. How do you achieve that? By somehow cutting expenses or arm-twisting your suppliers to give you some cost reduction. Unfortunately, these tactics aren’t likely for small businesses.
Reasons to Raise Your Prices
Raising your prices – though sometimes uncomfortable if you’re doing it for the first time – can actually be a good thing.
1. Great customers aren’t price shoppers.
Think about your current client roster. Picture the ones you love the most – they value your services and relationship and are not the exasperating negotiators. Grade your clients; put them into A, B, C, D, or F categories. I guess that Ds and Fs are always looking for a cheaper deal – they aren’t loyal, and they require too much of your time.
I have worked with many businesses that have raised their prices successfully without losing sales. In fact, my unscientific rule is that most small businesses can raise their prices by 10% with the loss of only a few customers.
Let’s do the math again. If you have a 50% margin and you raise your prices by 10%, you could stand to lose 17% of your sales before your profit would be reduced. Here is a fascinating chart that will show you how to calculate the impact of discounting and raising your prices.
2. Customers love long-term value more than a one-time deal.
Try to add free items or premium service to the sale. What result do you see?
I recently saw an advertisement for a driveway reseal company offering a 10% off coupon as an incentive. Arguably, the offer would have been better and more enticing if it included a new roadside mailbox installation instead of the price discount. Think about what you can add-on that will increase the value perception of your clients.
3. Work on delivering exceptional service to justify a price increase.
You have a major advantage as a small business owner over bigger competitors: you can create a powerful service offering far superior to the “big guys” at a much faster rate. When you add value for your customers, they can easily rationalize a price increase.
4. Understand your niche and fine-tune your offering.
Larger competitors generally serve a wider spectrum of people. They need a bigger customer base to support their significant investment; however, this often comes at a cost to them, as they can’t give all their customers the support a smaller company (like yours!) can.
Small business owners can cater to a smaller market by developing a highly tailored offering and personalized service, all of which can justify a higher price.
Value will always trump lower prices. Understanding the disadvantages of discounts will help you look for other alternatives to win your customers’ hearts, even after a price increase.
If you need help with differentiating your business from others, sign up for my complimentary one-hour coaching session. Please fill out my contact form.