Cutting prices can be one of the quickest ways of boosting sluggish sales and improving profitability.

But even though price-cutting is an easy tactic to implement, its strategic implications can be profound.

This is because Pricing affects everything: Revenue, Profitability, Sales Volume, Inventory, Cash Flow, Competitive Strategy and Branding.

 And so a price-cutting strategy must be very carefully thought through, its expected impact scientifically calculated and its implementation handled with great care.

We’ll cover all these topics in this article.

Topics

  1. PRICE: One of the 4 ‘P’s of Marketing
  2. Align Pricing with Business Objectives
  3. Pricing, Sales Volume, Revenue and Profitability
  4. Price-Cutting as a Competitive Strategy
  5. Price, Branding and the Perception of Value
  6. Benefits of Price-Cutting
  7. Risks of Price-Cutting
  8. Different ways of cutting prices
  9. Key Takeaways

PRICE: One of the 4 ‘P’s of Marketing

Price is one of the 4 Ps of Marketing, the others being Product, Promotion and Place.

Together we refer to them as the marketing mix.

And as such Price is the ‘P’ on which you may have the greatest control in the shortest time.

Think about it.

Once you’ve designed, manufactured, or acquired a product to sell and filled up your warehouses with it, it isn’t easy to replace it.

Once you have a Place – a physical shop, an online store – it isn’t easy to suddenly replace it with another.

Once you’ve selected a Promotion strategy – advertising, social media campaigns, mail orders, etc – it isn’t as easy to change it either.

However, you can decide to drop your price from one day to the next with relative ease. You can offer discounts (a form of cutting prices) linked to volume purchases. Or you could offer a “buy one get one free” promotion (another form of price-cutting). If you sell a service or offer a product as a service, you could give 2 months free to customers who subscribe for a year. This too is a way of cutting prices.

The bottom line is this: Pricing is a lever that gives you the greatest flexibility to design a marketing mix that helps you achieve your business objectives.

Align Pricing with Business Objectives

Like any strategy, your Pricing strategy needs to be linked to your business’s short-term and long-term objectives.

Here are some questions to ask and consider while linking Pricing Strategy to Business Objectives.

  1. Are you looking to increase sales in the short term? And do you think cutting prices will do the trick? Or is raising prices the answer?
  2. Is your objective to increase sales or is it to increase profit? Are you willing to cut prices to increase sales but accept lower profits?
  3. Is it your objective to push old inventory out of the door? And will price-cutting make sales of these older products more likely?
  4. Do you sell perishable goods? And/or so it is an objective of inventory management to reduce product shelf time? If so, will cutting prices make this happen?
  5. Is it your objective to market to certain target segments and is pricing a lever to attract customers from this segment?
  6. Are you working towards positioning your brand at the high end of your market? If so, will price-cutting impact your customers’ perception of your brand?

These are just a few of the questions you can and should ask while designing a pricing strategy that helps achieve your business objectives.

And these are not easy questions to ask, and the answers will have a profound impact on how you decide to price your products and what that does to your position in the market.

Pricing, Sales Volume, Revenue and Profitability

To help answer some of the questions we’ve raised in the previous section, you will need to understand the relationship between Pricing, Sales Volume, Revenue and Profitability in your business niche.

Price Cuts and Sales Volume

If you have customers who are not buying from you and are unlikely to buy from you unless you cut prices, then price-cutting as a strategy is likely to convert these customers and increase the sales volume of your products.  

In such a scenario, price-cutting could be a good way to push more products out of the door and into your customers’ hands.

But beware: An increase in sales volume may not automatically mean an increase in revenue. It’ll depend on how much you cut prices and by how by much your sales volume increased.

Price Cuts and Revenue

Intuitively it may seem that cutting prices will reduce Revenue. This is true if you count revenue from a single product. After all, if you cut the price the customer’s going to pay you less.

But if the sales volume (number of products sold) increases sufficiently, you can make up for that drop in revenue-per-product by an increase in total sales across the entire sales volume.

However, note that just because your overall sales go up, that doesn’t mean your profitability will go up. In fact, it could be just the opposite.

Price Cuts and Profitability

A price cut is immediately going to lower your profitability-per-product. That’s clear.

The cost of making the product or acquiring it hasn’t changed. And so, if you cut its sale price, you are going to cut profitability per product sale.

However, if you can now sell much higher volumes of your product, you can grow overall profitability even while sacrificing profit over each individual sale.

Finding this sweet spot where you lower the price just enough to maximize sales or maximize profitability is a science and not an art.

We recommend modeling different possibilities in an excel sheet and making sales estimates at different price points to find the optimal cut in price to achieve your objective.

Pricing-Cutting as a Competitive Strategy

Cutting Prices to raise Barriers to Entry

If you are an established player in your market and enjoy healthy margins, one way to erect a moat around your business and keep competitors out is to cut prices.

You’ve already overcome the barriers to entry into your market and have staked out a position in it. Maybe you’re also benefiting from economies of scale.

Why not use these assets to your advantage by cutting prices and making it difficult for new entrants to enter the market and threaten your position?

But be careful: a smart new entrant could also have the same trick up their sleeve.

That’s next.

Cutting Prices to enter new markets

In this scenario, you are the new entrant. You are trying to get into a market where there are established players. They have put in place barriers to entry and are enjoying economies of scale.

So, what do you do?

One strategy could be to cut prices.

By cutting prices you could lure away some customers who are looking for a cheaper alternative. This could give you a toehold in the market.

And instead of cutting prices across the board, you could cut prices strategically.

For instance, you could offer a one-time discount to new customers. Or you could offer free upgrades if customers stay with you for a minimum of 6 months.

The point is that as a new entrant to the market, you could use price-cutting as a strategic tool to turn the tables on more established competitors who may be more complacent in their position.

Loss Leaders

An extension of the previous strategy – that is to cut prices to enter new markets – is the Loss Leader pricing strategy.

In this strategy, you price a product so low that you could even make a loss on it.

The objective isn’t to make a deliberate loss but rather to bring the price to such a low point that none of your competitors can come close.

But if you do make a loss in the process, so be it. That’s the idea.

And that’s why it’s called a Loss Leader strategy.

For the Loss Leader strategy to make sense, first of all, you will need deep pockets to absorb the losses.

Secondly, you’ll need to ensure that down the road you can sell other products or services at high enough profits to make up for all the losses made upfront.  

Pricing, Branding and the Perception of Value

As humans, we are hard-wired into assuming that something expensive must be of better quality.

Similarly, if something is hard to get, for instance, because it is too expensive, we find it to be more desirable.

This is a point you should strongly consider before cutting the prices of your products.

If you cut your product’s price, will your customer or the consumer want it just as much?

And how will they perceive your product and your brand?

If you’re in the luxury market, offering deep discounts may make your brand look “cheap” even though the product is anything but cheap.

And you may never recover from the hit your brand will take.

In the same way, if you were to offer a massive discount (say 50% or more), what will that do to your credibility? Could it make people think that your original pricing was just bogus?

Price-cutting can be a very sound and legitimate strategy. But think carefully of the broader implications. Think about how it will affect your brand, your credibility and the long-term sustainability of your business.

Benefits of Price-Cutting

The benefits that you could potentially get from cutting prices are:

  1. Increase in revenue in the short term through an increase in sales volume
  2. Increase profit by increasing sales volume even if profit per item sold drops
  3. Push old inventory out of the door
  4. Reduce product shelf-time
  5. Build a moat around your business to ward-off new entrants
  6. Gain entry into new markets through a low-cost approach

Risks of Price-Cutting

Here are the risks associated with a price-cutting strategy:

  1. A lower price may not result in sufficient increases in either revenue or profitability
  2. Price cuts could create a negative perception of your brand
  3. Massive price reductions can harm your credibility
  4. If your customers get used to a price cut, you may not be able to raise prices again
  5. Price cutting can hurt your cash flow if it does not result in more revenue and profit

Different ways of cutting prices

Temporary Price Cuts: Discounts

The quickest way to implement a price cut and study its impact is to offer a temporary price cut or discount. The temporary price cut could be linked to the season (Summer sale) or a festive occasion (Thanksgiving sale).

Temporary price cuts can be a way to quickly boost revenue and profits without having to lower COGS or renegotiate the acquisition cost of a product with your supplier.

Temporary price cuts also have limited cash flow downside and can be applied strategically to products and brands where they would provide the greatest upside.

Permanent Price Cuts

Permanent price cuts can make sense if you’re certain that the lower price is going to result in sustained growth in revenue and/or profit.

Permanent price cuts could require you to cut your COGS and or the cost of acquiring raw material or finished product for resale. This is the only way you will maintain your original profit margins.

Permanent price cuts could also be part of a larger strategy to retain market share in an environment where prices are always dropping.

Price cuts linked to customer actions

Price cuts that are contingent upon customer actions can be a great way to offer benefits to the select group of customers who are performing actions you would like them to.

For instance, you could offer a discount to a customer who signs up for a loyalty program.

Or you could offer a discount to a customer who buys a certain volume of product.

Or you could make a “buy one get one free” offer to a customer who purchases a specific product. A “buy one get one free” offer is a price-cut disguised as a freebie.

Or you could offer discounts on certain products only (eg products nearing an expiration date).

Price cuts linked to customer actions are a great way to deliver value to those customers who are providing you with the greatest benefit.

Key Takeaways

  1. Price is one of the 4Ps of marketing but the easiest to modify.
  2. Any Pricing Strategy (including one of cutting prices) should be tightly linked to business objectives.
  3. Before undertaking a price-cutting strategy, understand the relationship between Pricing, Sales Volume, Revenue and Profitability in your niche.
  4. Remember that cutting prices could increase revenue but that might come at the cost of profitability. So be clear about your objectives.
  5. Price-cutting can be a great competitive strategy to guard your position in the market by raising the barriers to entry.
  6. On the other hand, price-cutting can also be a great way for a new entrant to enter a market with entrenched competitors.