While many factors determine the long-term success of a business, one important element of a business plan is setting the price for the products or services offered to customers. At a minimum, the revenue derived must cover fixed and variable expenses for overhead, cost of goods sold (if applicable), and in the case of a sole proprietorship, generate a sufficient net income from which to earn a living. Similarly for a corporation, revenues must allow for paying sufficiently skilled people who are able to support themselves by working as employees for this business rather than finding work elsewhere.
While these criteria are relevant to the entrepreneur, they have absolutely no bearing on the interests of the customer. The customer’s sole interest lies in whether his or her purchase yields good value.
Simply stated, value = benefit ÷ cost, or alternatively, everything is relative. A product or service is considered to be a “good deal” or “bad deal” compared to something else. If the derived benefits between two items are similar, then the lower priced item is of greater value. However, if two items yield significantly different benefits (or provide a similar type of benefit but at substantially different magnitudes), then comparing the costs alone between the two is immaterial.
On a recent episode of Top Chef Masters, one of the contestants serves a $5,000 hamburger at his restaurant, and he proudly claimed that they actually sell a number of these plates on a regular basis. By contrast, as evidenced by the government’s recent “Cars for Clunkers” program, this amount of money exceeds the market value of a perfectly functional, albeit aged, automobile. So for this same price point, a market exists for each item even though the provided benefit and scale of pricing for a hamburger versus an automobile are widely disparate. By this illustration, price points alone are nearly irrelevant unless dealing with commodities, in which there is little to no differentiation in benefit provided for a given product or service and competition is primarily driven by price alone.
Given the economies of scale available to large businesses or franchise models, the small business owner will likely find it much easier to compete through clearly differentiated benefits in lieu of low-margin commodities in order to provide a high level of value to customers. A commonly used term for concisely identifying this aspect of a product or service is a unique sales (or value) proposition, or USP/UVP. In the current economy, there may be a knee-jerk reaction to move toward a commdity-scale pricing based on the perception that a product or service is dropping in value as consumers use more discretion when spending. Is this actually a rational move?
Keeping the value equation above in mind, products or services whose benefits are clearly known and articulated among competitors remain of good value even if discretionary spending dollars are more scarce. After all, how does the state of any external economic condition affect the benefit offered by a product or service which has a timeless quality and solves a basic problem for people? Highly beneficial products and services have relatively inelastic demand, which essentially means they are price insensitive for a fixed supply.
The challenge for the entrepreneur is to be particularly clear on communicating the key benefits, uniqueness, and differentiating elements of one’s product or service. In doing so, one essentially avoids having any real competition in the marketplace and rather serves a niche by providing something which is simply unavailable elsewhere in the same way (scarcity) and thereby generates great value for customers. This method lends to having a recession-tolerant business which is sustainable through the cyclical nature of any given market.