Many entrepreneurs in a recession think that lowering prices is the best way to increase sales and keep their existing customers. Additionally, many of them lower prices to eliminate competition and to increase revenue and sales. And in many cases, they do that!

You have probably seen how some grocery stores use lower grocery prices. However, a very small percentage of them succeed with this strategy.

True or false: setting your rates below what your competitors charge for similar products and/or services means that more people will buy from you versus making a purchase from them.

Pricing lower than your competitor is a mistake that many small business owners make. Why?

Because there are many hidden and visible negative effects on the business when you use such a pricing strategy.

Let’s discuss how lower prices can impact your business.

The Pricing Dilemma

Are you aware of the dilemma of a lower-price strategy? It’s easy to get on that path, isn’t it?

You see competitors that are selling what you sell for the same price like you, and you lower your price to compete. Or, you feel the feature you’re selling isn’t so special, and your price is too high. Or, you just want to make a lot of sales, and you think lowering your price will help.

The danger of low pricing is it will eat into your ability to make a profit because a price decrease can lead to lower profit margins. Let me show you what I mean.

Let’s say you sell a widget, and you normally sell it for a $200 price rate. It costs you $150 to make it, so your profit is $50 per widget. Now, I’m not saying $200 is the perfect price. Maybe it is, and maybe it isn’t. What I am saying is that if you lower your price to $180, your profit is now $30. Let me show you what I see if you’re not tracking this.

If you lower your price to $180, you lose $20 per unit in profit. If you sell 10 of these widgets a week, you lose $200 per week in profit ($20 x 10) and $10,400 per year (200 x 52 weeks).

On the other hand, if you raise your price to $220, you will increase your profit to $70 per item. This sounds good, but how many widgets do you think you’ll sell? If sales drop off significantly, you could lose even more money. This is something I call the pricing dilemma.

Remember, price is a big factor in many buying decisions. It’s not always the only thing, but it’s often a close second to features and benefits. If you’re not charging enough for your widget, you may not have the money to improve or invest in your business growth.

And, if you’re pricing lower than your competitors, what kind of customers are you attracting? Are you attracting the right customer?

How are you going to increase your pricing to show the real value of what you offer?

Getting Caught Up in a Price War

Do you quickly lower prices to attract more customers? If so, you’re not alone. But, a price war can be dangerous for your small business. When you lower your prices, it’s likely your competitors will follow the same. And, once you start a price war, it’s hard to stop.

Imagine this: you lower your prices to compete with your competitors, and they respond by lowering theirs. Soon, you’re all in a full-blown price war. Your profit margins are lower, also.

Plus, price wars have a negative impact on your customer loyalty. If you lower prices to attract customers, they may expect such low prices in the future and be angry if you ever try to return to a reasonable pricing structure. And, if you do need to raise prices in order to stay profitable, you must ensure that customers will continue to buy the right value of your products and services again.

And, if you’re offering a lower price because of a price war, customers may assume your products or services are lower in quality, too.

So, when you become a part of the price war, it is really challenging for you to maintain your market share and brand reputation.

The Economics of Pricing

Pricing isn’t just a bunch of numbers; it’s a critical element of your business strategy. To succeed and continiously remain competitive in the market, you need to understand the economics of pricing, which means knowing how price affects demand and revenue before you go with price cuts.

When it comes to setting the right price, there are several factors to consider, including your costs, target market, competition, and pricing strategy.

A well-designed pricing strategy can attract the right customers, boost sales, and maintain healthy profit margins.

Without a solid understanding of the economics of pricing, you may end up with a price that’s too high to attract enough customers or too low to cover your costs.

Know Your Costs

The first step to determining the right price for your products and services is to understand your costs. This includes your fixed (rent, salaries, etc.) and variable costs (materials, production, etc.).

Knowing your total cost of production will help you choose the right pricing strategy that will maximize revenue and profit for your small business.

Pricing Strategy

There are several pricing strategies to consider. Cost-plus pricing strategy involves adding a markup to your costs to ensure profitability. Value-based pricing strategy sets prices based on the product’s value to the customer.

Competitive pricing strategy on the other side, involves pricing your products and services similarly to your competitors. Each strategy has its advantages, and the right approach depends on your business and circumstances.

Read more about pricing strategy in our ultimate guide to pricing strategies.

Visible Negative Effects of Price Reductions to Succeed

In many cases, you can see only the profit as one negative effect of reduced prices. But this is not the hidden effect on your business. Let’s see one example:

Sales Price	$100.00	$90.00
Costs	$80.00	$80.00
Items Sold	50	50
Total Income	$5,000.00	$4,500.00
Profit	$1,000.00	$500.00

From this table, you can easily see what happens when you are lowering your prices. You sell your product for $100.00 and cut your price to $90.00. So, if you cut your price by 10% of your current price, your profit will decrease by 50%.

As you can see, reduced prices lead to reduced profit margins, which can significantly impact your business’s financial health. This has a big negative effect on your business. But, you probably think that by lowering prices, you will sell more products. Let’s see this comparison in the example below:

Sales Price	$100.00	$90.00	$90.00
Costs	$80.00	$80.00	$80.00
Items Sold	50	60	100
Total Income	$5,000.00	$5,400.00	$9,000.00
Profit	$1,000.00	$600.00	$1,000.00

As you can see from this example, if you sell 60 pieces of your product or service, you will have a $600.00 profit. If you want to have the same profitability level as before the price cutting, you must sell 100 pieces.

So, a profit of $1,000.00 will require a 100% increase in sales when the price is cut by only 10%.  Do you think that with 10% lower prices, you can succeed in improving sales by 100%? I believe that this is impossible. These are visible effects when you lower the prices.

Here are eight reasons why your small business is not profitable and what you need to do in order to succeed.

Hidden Negative Effects of Reduced Profit Margins to Succeed

Let’s talk about the hidden effects of price cuts and lowering prices.

Negative Effects on Brand Reputation

When you cut your price, you will immediately decrease your reputation as a business with high-quality products and services. Customers expect a reasonable price that reflects the quality and value of the products and services they receive. This means that your customers will think that you have lowered your prices because of the low quality that they will get from you.

The Message: You Have Charged Too Much

Another possible thinking for your long-term customers can be that you have charged them too much in the past period of doing business with you, leading to reduced prices now. Because of that, there is a significant possibility that when you lower prices, you lose some of your current customers.

Your Competition Will Also Decrease Their Prices

Another thing that becomes a part of the hidden effect is your competition, which will also lower their prices. Because of that, you cannot expect many new customers because the prices will still be the same. Additionally, your lower profit margins will make it difficult to sustain your business.

You can see that the two effects of lower prices are not so good for you as an entrepreneur. With the visible results, you must increase your sales by 100% if you want to make the same profit. With the hidden effects of lower prices, you can lose some proportion of your current customers and probably enter into the price wars. Those two things are opposite to each other. Because of that, lower prices is a bad strategy.

Commanding Higher Rates with a Pricing Strategy

The answer to that question is to develop a sales system “that puts the client first,” says Ruffino. When you do this, you’re able to charge higher rates, and your customers will be more willing to pay them.

While commanding higher rates, it is also important to ensure that customers perceive the value they receive as a reasonable price for the quality and service provided.

Putting clients first also helps you close more deals after the first meeting versus requiring multiple follow-ups in an effort to make the sale, says Ruffino. But what does putting the client first really mean?

Although he doesn’t come out and say, there are a number of things you can do to make your customer a priority. One of the most basic is to offer stellar customer service.

The Benefits of Raising Prices

While it might seem counterintuitive, raising prices can be a smart move for your business. Higher prices can lead to increased revenue and improved profit margins, provided you carefully consider the potential impact on demand and customer loyalty.

When done correctly, raising prices can help you maintain your market share and enhance your brand reputation. Customers often associate higher prices with higher quality, which can boost your brand’s perceived value. Additionally, higher prices can provide the financial cushion needed to invest in better products, services, and customer experiences, further solidifying your market position.