Q: My business has been operating for three years now. It was doing great when we started but things have slowly changed with the entry of more competitors in our market. Our sales have been declining lately due to the competition. What should I do? – Fritzy by email
A: When the business is slowing down, pricing always becomes a challenging task for entrepreneurs. As the combined pressure of weakening demand and excess capacity brings down prices, managing gross margins becomes problematic especially if the business has high fixed expenses to begin with.
Sometimes when there are imbalances in the global supply and demand for raw materials, the costs of some items may also increase. When this happens, business profitability obviously becomes highly volatile. What do you do then as an entrepreneur?
The usual approach to this situation is to look at your margins. Normally, you would be hesitant to cut your prices because you hate to give a portion of your profits. But when sales are slowing down, you may be forced to lower your prices to get the business you need.
Sometimes depending on the price sensitivity of your product or service, a price cut could in fact bring you higher sales, and thus give you greater profits. But what happens when the market does not react positively to your price cut? You would not only have lower margins coupled by lower volumes, but you would face potential losses as well.
Understanding the market positioning of your product or services is important. If you are in a business where you are one of only a few suppliers in the industry, a price cut would definitely boosts your sales, but would not do as much to your profits. If you raise your price, on the other hand, you may not lose so much business because your customers would have no choice but to buy from you.
In contrast, if you are in an industry where you have several competitors, a price cut may not guarantee you higher sales because your competitor may react by also lowering their prices, thereby bringing the market completion to status quo. But then, if you enjoy a strong brand in the market, you would probably have an edge over your competitors.
When you consider lowering your price, it is important to determine your costs components—your variable costs and fixed costs. Variable costs are expenses that change in proportion to business activity; that is, if your sales go down, your variable costs should also go down.
An example of variable costs is commission expense paid to sales agents. If no sales are made, then you do not pay any commission. Variable costs are normally direct cost in nature so you do not incur it when you do not generate any sales.
Fixed costs, on the other hand, are expenses that are independent on your business activity, meaning that regardless of whether you have any sales or not, you would still incur the same expenses. Example of fixed costs include electricity, rentals, and salaries of staff.
When you know your variable and fixed costs, you would be able to compute your breakeven sales. If you have a low breakeven target, you could afford to experiment with the market by lowering your price. Otherwise, if your breakeven volume is high, you would risk experiencing losses. In this case, it would be good to create a contingency plan so you can measure how much risk you are willing to take.
Another approach is to look at your competitors’ capability. If you think you enjoy certain cost advantage over your competitors, perhaps a lower variable costs or lower fixed costs, you can actually be more aggressive in pricing your products.
Lowering your price will not only protect your margins but also increase your market share. If your business sells various products, you can study each market segment and identify your competitors that belong to each particular market segment.
You can also try to do a hybrid approach by raising your price in some markets where you are relative strong, and lowering your prices in other markets where you have many competitors. This is possible if you have several branches all over the country. You can unload some for your slow-moving products at bargain prices in one market while keeping hardline pricing in another market. In this way, you will be able to move your inventory faster and convert them to cash flows.
Having good pricing strategy is more important than ever. Especially in the volatile market environment that we have now. A slight adjustment in pricing can spell a major difference between profit and loss.
Also, regardless of the pricing strategy you are implementing, it may now be a good time to check your sales incentives to your agents. Instead of reducing them, it will be good to give more commission to people who bring you more business; for example, when they achieve certain quotas.
In this way, you can ensure that the costs of your lower price is compensated by higher profits. You can also evaluate the discounts you provide to you customers to ensure that these discounts justify the incentive you are giving for the guaranteed business volume. You can also review that prices you have for all of your products and compare then with those of competing products to allow you to identify which products need a price adjustment.
Henry Ong, CMC, is president of Business Sense Financial Advisors. You can follow him at@henryong888 or email hong[at]businesssense.com.ph.