Most business startups are created to take advantage of some kind of benefit or need the founders have identified in the market. They see a problem, create a way to offer a solution and — presto — a business is born. Customers are so happy to have their problems solved they pay a healthy price for the new products or services.
Gross profit margins usually start out looking rosy. The challenge comes as the business grows. Unless there are barriers in the market that prevent competition, other companies see what this bright young startup is doing and copy it. Now customers can pick among options and suddenly price becomes an issue. Should a business cut prices to stay ahead of the competition?
The answer isn’t as simple as it might seem. Certainly, vying for customers on price is an effective way to run a business. However, any business that successfully stays ahead of the competition by offering lower prices is operating with a commodity based business model. Examples of successful commodity businesses can be seen all over the Grand Valley. The big, obvious one is Wal-Mart. Commodity businesses constantly strive to offer more value at lower cost to more customers. This business model is all about more volume at lower costs.
An entrepreneur facing price pressure should pause and make sure his or her long-term strategy is in line with operating in a commodity business model before dropping prices. Startups usually enjoy a nice niche in the market. If new competition creates pricing pressure and the business drops prices to maintain or grow market share, the business is choosing to create an advantage with price. All good — but now the business must focus on growing volume and reducing costs to maintain that advantage. The business strategy is to get bigger and bigger all the time while also becoming more and more efficient. Sound familiar to any of you? It’s a commodity game.
So what’s another option? Say you want to remain unique in the market, have no aspirations of becoming a multinational presence and like the fact people pay a little more for your products. Instead of giving in to price pressure, innovate.
Consider the iPhone. It was new and innovative in the market and for a few months people paid $299 to gain access to new applications and the cool touch screen. They hardly gave it a second thought. Well, now the market is full of touch screen telephones comparable to the iPhone in features and price. So what did Apple do? The company raised the bar — and in the process, doubled the price. The iPad is different, meets the need in a different way, offers new value and costs $599. Apple innovated and offered something better.
Put yourself in Apple’s place and imagine that your competition has matched you in quality and price, so you decide to double the price. That takes guts.
Businesses that operate on a niche business model stay ahead by offering new, unique and creative options for their customers, not lower prices. Niche businesses require a completely different business model. While commodity business must focus on providing more for less, niche businesses must deliver something beyond customer expectations. This is tough. And once you jump into this niche game, you have to repeatedly deliver successful innovation. This is really hard, because you can’t churn this stuff out like you can streamline a production line. It takes dedication, creativity and constant change. It’s hard, but it’s also a viable alternative to competing on price.
Don’t react to the market and just put your stuff on sale. Pick your business model, commodity or niche, based on where you want your business to go and how you want it to grow. Choose your business model first, then set your price.