Updated: Dec 1, 2020
A few days back I conducted a poll on LinkedIn requesting my connections to choose between two options which they could potentially face while dealing with the Covid crisis. I received a decent response- 83 votes.
The first option, viz., accepting a 20% lower price received more votes (58%), as compared to the second option, viz., letting 20% of the business volume go due to the price (42%).
This result was in fact, a bit of a surprise to me. I expected that the ratio would be approx. 75:25 as against 58:42. In my experience, most business leaders prefer to lower the price to get the deal. Probably the result is a bit different because there is a higher degree of awareness of the criticality of maintaining the price level. Alternatively, it may also reflect my network’s composition, which includes many experts in finance and marketing!
The decision of whether to lower the prices or let go the business is not straightforward. It should not, therefore be taken on an impulse, i.e., fear of losing business versus fear of running losses.
I believe the following variables would determine which alternative one should take:
What is the nature of your business? Are you in a business, such as hospitality (hotel) where a room that is not occupied for a night is a revenue lost forever? Or a similar business, such as airlines? In that case, you may have to use marginal pricing strategies and offer lower prices dynamically as demand emerges.
What is the gross profit margin (roughly translated into contribution margin) in your business? Or alternatively what is proportion of variable costs of production and delivery as compared to the fixed costs? Higher the contribution margin, say, 40%, maybe you can afford to lower the profit, and recover part of fixed costs of running your business.
How sensitive is the demand with respect to the price, i.e., what is the price elasticity of demand? If the elasticity is high, by reducing the price, you will be able to get higher volumes. If the elasticity is low, adverse impact of price reduction may not be adequately compensated by increase in the volume?
Who are your competitors and how are they dealing with this situation? If the competition has deep pockets and can afford to take losses for long, you may end up making huge losses in trying to win the business by lowering price. A competitor with dep pockets, who has a goal of ruthlessly retaining or gaining a market share will be able to beat you down on the price, while remaining solvent. You may not afford that and may land into more desperate situation.
What is your brand’s positioning? Are you a premium brand known for delivering outstanding value through brand association? Do your customers buy from you to add to their self-esteem and enhance their social status? If yes, dropping your prices by as high as 20% will dilute your positioning. Remember, price is an inseparable part of positioning.
How easy or difficult is it for you to go back to normal or usual price? What is the bargaining power of your customers? If you are a business-to-business (B2B) player, your product’s price impacts your customer’s product price. They may not be willing to pay you the normal or usual price when the economy recovers from Covid.
Are you able to clearly communicate to your customers that your price reduction is a one-time special exercise in view of the Covid crisis? If you are able to successfully communicate, then it may be easier to move back to the normal or usual price by engaging with the customers, as the economy recovers. If not, your new low price may become the normal or usual price in the eyes of the customers. Have you considered offering a “Covid discount” that appears as such on your invoice, reminding the customers that it is temporary?
Have you fully explored other options available to you, besides lowering prices? E.g., have you considered
Offering a tiered volume discount than offer a lower price to all the customers?
Offering lower price only to a specific customer segment, in specific, the segment which has high price elasticity of demand?
Giving higher referral coupons or rewards than merely offer higher discount upfront? Referrals generate higher volume of sales.
Bundling products and offering discount on the bundle, so that the discounts are tied to sell of products that are high margin or low traction?
Modern pricing strategies such as transaction-based pricing, rather than reduce price of the product upfront? Transaction based pricing links your volumes and profits to customers’ business volume.
Aligning your prices with customer business goals, e.g., with lower risk, improved compliance, higher sales, lower costs etc.?
Have you carefully considered all the available options?
The above is not an exhaustive list of factors to consider while deciding on which option to choose.
The decision to lower the prices to get volume of sales should therefore be a conscious decision that considers all the above aspects.
The Covid crisis is a black swan event. No one can predict such event or prepare fully for such event. We can only carefully consider all available options and make a rational business decision that helps us in the long run.