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Value Based Pricing, Not Price Cutting

By Paul Lemberg
Posted Monday, January 31, 2005

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Value Based Pricing, Not Price Cutting

The oldest tactic in the world to get a sale moving is to cut the price.

And it does work...but the question is, "At what cost, and can you live with the bargain?"

In the past three years it has taken longer and longer for your prospects to make up their minds, and for you to close a sale. And one typical salesperson's response to people not buying-for whatever the reason-is to say, "Would you buy if... ?" The "if" of course, is always some variant of, "...if the price was lower?"

It's the number-one classic response from sales people and owners of entrepreneurial companies who want to stimulate the buy. It certainly was the question asked by every sales manager I've ever worked for. Entrepreneurs and executives feel that end-of-quarter pressure to "make the numbers" and almost automatically start playing the tumbling price game.

In many industries, it's become an institution to give away all the profits In fact, we have even trained customers to expect it that end-of-period discounting, and many won't even consider buying without it.

The trouble is, people today are not 'not buying' because your price is too high.

They can afford your product at its current price. The reason many companies aren't buying is so they can conserve their cash and because they don't see a sufficiently compelling value to say "YES" and part with that cash right now.

Cutting your prices won't help. Since high price is not the problem, lower prices won't lead to new sales and when it does, the effect on your profits can be devastating. Follow these numbers:

Let's say you sell a product for $100. (Or $100,000, the concept is the same.) Your cost is $70. That means your product carries a thirty percent margin-your profit is $30. Now, to make a sale, you feel "forced" to cut your price by twenty percent, leaving your new selling price at $80.

All things being equal, your profit is now $10 instead of $30. That means a 20% price reduction cost you 66% of your profits. TWO-THIRDS OF YOUR PROFITS for a 20% price reduction! Cut your price much more and your profit quickly goes to zero. Or lower.

But that's not even the worst of it. Once you lower prices, they tend to stay low. That $100 widget you just sold for $80... Well, sorry to say, but it's now an $80 widget.

And worse than that: your competitors will almost definitely lower their prices, and you, my friend, are in a price war. To win in this scenario, you need deep pockets to sustain a losing position for the duration.

So for these three reasons-depressed profit margins, permanently lowered prices, and the devastation of a price war-it's a bad idea to lower your prices to buy business-regardless of the economic climate.

What can you do instead?

Here's an interesting example. One of my clients-a software company-had a hot prospect who didn't want to pay for maintenance. They felt that 18% per year was just too expensive, and wanted to pay for support ad hoc instead.

My client knew this was a bad idea. Customers without maintenance contracts typically become your worst customers. Why? Because they know it's going to cost them to pick up the phone for support, so they try not to. Thus, then they don't get the right level of service. They don't know how to use the product. They don't get the results they want.

And even though it's their fault for skimping, they point the finger at you and badmouth your company.

On my advice, my client offered the prospect a four year non-cancelable contract, and gave them the first year for free. Now really, this is a discount. It just doesn't look like one. It's a 25 percent reduction in total purchase price, but it doesn't affect the selling price today or tomorrow.

Plus, my client locked in that customer for four full years, during which time they expect to sell them additional products and services.

Conclusion: Price cutting is the "lazy man's" response when it's hard to make sales. Unfortunately, this doesn't boost sales, it merely results in drastically lowered profits on the sales that do get made. Often the results are permanently reduced prices and margins, and a price war, which has disastrous results on all players, except very deep-pocketed ones. There are other approaches that not only maintain price levels, but even support higher ones.

About the Author
Paul Lemberg helps people and their companies succeed faster and more profitably than they ever thought possible. Over the past 14 years, he has transformed more than 200 companies and is currently President of Quantum Growth Coaching, Inc., the world's first Business Coaching Franchise built to systematically create more profits and more life for entrepreneurs... Guaranteed. More articles by Paul can be found at (http://www.marketingsuccessdaily.com)