Question: When Should You Compete on Price?

Hi-

I’ve had several reader and listener questions on price that I have been wanting to record responses to…today, I’ll answer one submitted:

The question is: What are my thoughts on when a business should or shouldn’t compete on price against competition with a similar/same product?

I’ll point to three considerations before entering into a price competition on a similar product or item:

Brand Considerations:

At the most fundamental level, what does your brand stand for?

Take the iPhone as an example, Apple could compete on price with any provider because they operate retail locations, design the phones, and control the manufacturing of their phones.

They control the whole value chain.

Yet, you never see Apple discount the iPhone. They may offer incentives at certain points like Black Friday, but I’ve only seen prices changed when a new model comes to market.

You want to consider your brand.

Are you premium? Low-cost? Middle of the road?

Potential Profit:

Are your costs of goods cheaper than the competitor?

If so, you may be able to compete at a lower price.

Why is this the case?

The contribution margin of your sale may be higher than the competition after the price cut which gives you room to run the price promotion and still profit from the sale.

As an example, you may be selling a product that has a 50% contribution margin at full price. If you cut the price 20%, you lose 40% of your profit:

100% price = 50%

20% = 80% of the price and profit at 30%.

So you have to know the profitability of your sale to know whether or not it makes sense to discount.

Reference Price Decision:

This is a term that refers to what customers think is the right price of something.

The question came to me from the world of tickets and this is a good example to teach you about the idea.

It isn’t uncommon to hear a pitch on posting tickets to college football at really low prices like $6. The explanation is that if people get into the game and see how great it is, they will come back and pay full price.

This is the logic behind penetration pricing as well.

Unfortunately, the research and my experience doesn’t back it up.

What I’ve seen time and time again is that people reset their expectations for what a product or service should cost. Once that reference point is set, it is very difficult to impossible to get people to rethink the set point.

So when you are thinking about competing on price, you have to consider the reference point your price will set.

Is the new price something you are comfortable with?

Is the new price harmful to ever achieving the real economic value of your product/service?