The Price and Value Thing

I work in a service industry.  Very often my clients -- small business owners who look to me for guidance -- fight a pricing battle with cut rate competitors in their marketplaces.  I encounter fee lowering and trepidation over pricing almost everywhere I go. 

It makes sense.  If your profit plan calls for you to charge $3 for an item and suddenly you start charging $2, then you have to sell half again as many items to stay even.  So, in this case a $1 reduction has to cause 50% more buyers to flock into your business -- which means additional expense in staff and facilities.  This is not voodoo economics.  It's simple math and I swear it's true:  reducing price by 1/3 means you have to sell 50% more items to be even.  Do the math.

The Consumer isn't stupid.  He expects to see some logic in your pricing:  it should make sense.  You price your service (or item) in a way that enables you to recoup your cost and make a reasonable profit.  Reasonable means different things to different people, but trust me:  unless you discover a way to provide your service or acquire your item at a cost that's drastically lower than your competitors, the marketplace will let you know very quickly if your desired profit is un-reasonable. 

In a service industry, discounters come in and say: 'Ok:  I'll say I do the same thing the other guys do -- which isn't a lie, because I get the same result (at least I intend to) -- but I won't spend time and money doing this and that and the other thing that they do.'  In other words they strip down the service to enable them to make a reasonable profit at a lower price.  If they are successful -- which means they take the market away from their higher priced competitors -- it means there was a flaw in the competitors' model.  Either they were doing things they didn't need to do to accomplish the objective or they were attempting to garner an un-reasonable profit. 

In these situations the traditional competitors bleed for awhile then inevitably change, either stripping down service to the same level as the discounter and charging a similar fee or reducing profit margins to a more reasonable level.  In time we realize the marketplace has made an adjustment.

This happened in the securities industry 20 or so years ago.  Back then, when you traded stock, you paid a broker 10% on each side of the transaction to make the deal.  Let's see, 10% on the purchase and 10% on the sale is 20% right?  And that's 20% of the value of the stock, not 20% of any realized gain.  In fact, it's 20% even if there is no gain or (shudder) even a loss.  Often, the broker made more than the customer, which makes no sense.  It's un-reasonable.  It's not logical.  Oh, Hell:  It's probably immoral.

Consumers were willing to go along because they saw no alternative.  The brokers had access to information and tools essential to the securities business that the consumer couldn't get at.  Securities firms were Information Silos.  They hoarded the information because they knew it was their livelihood. Consumers came to them to get access to the data and to someone to pull the switches to make the deal. Meanwhile, the firms told consumers that they were worth those hefty commissions because of their knowledge, their guidance, their experience, their track record. 

A brilliant man, Charles Schwab, took a look at this and his crap meter went way off the board.  He understood that there was nothing magical about trading stock.  Really:  any bozo with access to the information and the switches could do it.  So he designed a new model.  He gave the customer access to all the stuff the other guys were hoarding in their silos and cut those huge commissions down to a very reasonable fee.  Because he was expecting the consumer to do his own research (which, by the way, the consumer was delighted to do; we all want to be involved, you know), Charles didn't need all of those shirts hanging around rationing the information out . . . so his cost of doing business was much lower.

The whole world flocked to Charles Schwab's door, and he changed the industry.  Try to find a commission based securities firm today;  eveyone has adopted the Schwab model.  In fact, many discounters have stripped his model even further making Schwab suddenly look like a 'High Priced Firm.' 

What Schwab did was not discounting.  He didn't build a Merrill Lynch clone and simply charge less for it.  He found a more efficient way to accomplish the consumers' objective:  he let them do their own leg work.  Then, rather than let his own greed take over and price the new model similar to the other guys, he reduced his fee to allow for a reasonable profit.  The public LOVED it because it made sense. 

The lower fee got their attention.  It motivated them to investigate this new thing.  But they bought it because they saw how it could work.  People shop price but they buy value. 

It's like buying tires for you car.  You start noticing ads and you see this one shop coming up over and over again with some pretty good prices (at this point all you notice is price;  you barely even think about brands or quality) .  So when Saturday comes around, you stop by to see them.  They show you the cheap tires then show you how you can get something really good -- something that is safer and will last longer -- for just a little more.  And that's what you buy.  You shop price but you buy value. 

So, let's translate this to a service industry.  You have priced your service in a way that makes sense (the price enables you to recoup your expenses and make a reasonable profit).  You are tootling along doing your business and achieving your profit goals when suddenly someone comes in and offers to do the same thing for less.  Your first task is to tear your model apart.  Look at it from every angle.  Is it possible that these new guys have found a more efficient way to do your busienss?  If so, you better change and you better change quick.

On the other hand, if you discover that your model is sound and these new guys are just stripping down the service and hoping to make up the difference in volume, you have a war on your hands.  You are battling for control of the consumer's perceptions.  Here are some possible strategies:

1. Ignore them.  If your model is sound, they will find it impossible to make money with theirs.  They will take some business away from you for awhile, but ultimately they will have to either abandon their model or close shop.  The danger here is damage to your stature in the eyes of the consumer.  If the discounter is able to convince the consumer that you are overpriced (therefore greedy), that can have a lasting effect.  On the other hand, if you can show the public that they are cut-rate, flybynighters who bait and switch and don't deliver with the same level of success as you, you should be in good shape.
2. Unbundle your service and advertise a price similar to theirs for a level of service similar to theirs.  Then offer things you do routinely today as add-ons.  The price will get you in the door.  The assumption is that, fact to face, the consumer will see the value of your full service and choose you.  The danger here is being perceived as a bait and switch company. 
3. Stop advertising your price and emphasize that it's low low low and that you get more more more in service.  Emphasize your track record and results.  Assuming your discount competitor is kicking your but, look at his advertising.  Does it have a look about it or a catch phrase that resonates with the consumer?  If so, copy it. That neutralizes the uniqueness of their marketing and mushes it all together with yours in the consumer's brain.  Because you are a more established name, their advertising might actually drive people to your business.

Bottom line: people shop price but they buy value (is there an echo in here?).  Value is best presented face to face (it has to do with credibility, which is a whole nother topic).  Price gets them in the door.  And remember:  there's a difference between discounting and finding a more efficient way to do business.