I
t is normal and natural that price and value perspectives differ between buyers and sellers. A simple experiment highlights what is happening and can help us understand. It shows what occurs as the parties approach the transaction process. Here is one example that is taught in negotiation training.
Two groups of students are randomly selected. Each member of one group is given a cup and the members of the other group is not. The two groups are separated and not in contact with each other. The group without cups is independently shown a cup and asked what price they would pay for it. Their answers centered around $4. The other group, who had the cups in their possession, were each separately asked what they would take to part (sell) with their cup. These answers centered around $8.
Many experiments of this nature have been repeated with similar results. What is happening? It is human nature to value something “in our possession” higher than the same thing we do not have. Couple this basic human nature and it is no wonder that customers and suppliers have differences. The extent of this variance between the seller’s price and the underlying market value is important to determine. If there is insufficient understanding of the value, then there will probably be no sale. Consequently, as a business owner, it is your overriding responsibility to communicate and deliver value.
It should always be remembered
that As a buyer,
Price is what you pay and value is
what you expect to receive.
Conversely, as a seller,
Price is what you receive and value
is what you deliver.
Price negotiation between well-informed parties should result in a balance that the parties can maintain to foster a longer-term relationship. As the seller, you must position your product or service in the buyer’s mind to have “real value.” When you do that, you can ask for and receive good gross margins.
That is the basic picture of the market and the players. It should always be remembered that both you and your customer have perceived and real alternatives. However, if you want your business to survive and thrive, you must resist the impulse to cut prices. That is not to say that you cannot run a “promotional discounted product opportunity” occasionally. The key is a quick return to the needed level of gross margin required to run your business and to thrive.
Older, experienced, manufacturing managers often say when asked why they passed up a sale with very tight margins, “I don’t need any more practice in manufacturing!”
This means there is no reason to take an order without it having a sufficient contribution margin to make a meaningful impact on the bottom line.
Inexperienced sales personnel often argue for reducing prices. They are missing the understanding of the impact to operations and company profitability, not to mention the message it sends to customers.
Far too few managers understand the true cost of cutting pricing. This simple chart shows the required increase in sales for different “price discounts.”
The chart emphasizes the increase in units sold that are required just to break even for a given price reduction (that is discounts under various scenarios). This chart should drive the “price cutting” reality home. Use this chart to educate yourself and your managers. All businesses must work to maximize the gross margin generated. Without a focus on this measure and how price cutting impacts it, disaster may be close at hand!
Here is a quick summary on that point. When times are tough, it is all too common to reduce prices to maintain or to attract new customers. This should almost never be done. That is not to say that a properly structured promotion cannot be used within a larger strategy. If you are repositioning inventory or taking similar actions, that is a different set of pricing considerations. What we are discussing here is the high risk, negative results from “lowering” operating margins.
Here is an example to show why that subject is so important. If your gross margins are 40% and you reduce your prices by 10% you will need to increase the total number of units sold by 33.3% to generate the same margin dollars! Is that going to happen as you strive to survive a downturn? It probably will not happen even in good times, but it certainly will not be your reality in a slow market.
Please take a close look at the real cost of price cutting! The chart shows you how many more units, at the reduced price, you must sell just to earn the same gross margin you had before you cut the price. Do not drop your prices without utterly understanding what this table is showing you!
To avoid making this type of pricing mistake—Deliver value! Communicate that fact! Get the prices and margins every day that you need to both survive and thrive.
