Why Price Competition is Dangerous

The initial title for this post was going to be “Why Being an Asshole is a Poor Long-Term Strategy”, but I figured people might take offense at that for something they probably just consider good business.

Plus, my father wasn’t an asshole and I’m going to use him as an example here.

So…

Back in the 80’s my dad got into the sign business. (He’d previously been an accountant but when you need a job, you need a job. And he was one of those types of people who can pretty much do anything they put their mind to, so in a couple years he’d bought the place and then proceeded to be in the sign business until he died ten years later.)

Anyway. At the time he got into the business there were these lawn signs that most of the realty companies used. You may have seen them. They have a metal frame that sticks into the ground and are double-sided. Great for carrying around and putting in the yard of a house that’s for sale. Easy to install, easy to remove, easy to transport.

They were very cheap to make. Very.

But the sign companies at the time charged far more for them than they cost.

Which equaled opportunity when my dad entered the market, right? Hey, those can be made for something like 50 cents a pop and everyone is charging $10. If I charge $5, I’ll take all their business and still make $4.50.

(All numbers here are made up. I don’t remember them.)

Winning, right?

Until those people who’d just lost their very lucrative business undercut his $5 price. And then he undercut their $4 price. And then they undercut his $3 price. And then it got to the point where the last man at the bottom didn’t even want the business because there was no margin left in it.

Within a couple of years that entire market had collapsed and everyone was back to where they’d started but without that revenue stream.

See, this is why being the asshole is a short-term strategy. Because if your business is based on undercutting someone else’s price (or in the case that inspired this post, significantly overbidding your ad spend in a niche market), it only works as long as you’re the only one doing it.

If all other books are $7.99 and you price yours at 99 cents, you can suck up a lot of sales. Enough to make it worth it. But when everyone prices at 99 cents, then we all find ourselves in need of another job because the volume that made up for the low price goes away and all you’re left with is the low price and consumers trained to think that’s a fair price.

Same thing happens with ad bids on CPC ads. When you bid really high for ads but no one else does you have this perfect world where your ad is always at the top but what you pay isn’t near that mark. (Since Amazon at least only charges you a penny over the next highest bid.)

Problem is, that only lasts as long as you’re the only one doing it. Get three assholes doing the same thing and it’s mutually-assured destruction. Suddenly you’re actually paying that $10 per click. And when all you have is one poorly-written knock-off book to pay for that ad spend, well… Like I said. Short-term strategy.

Only question is how many people it takes out before it fails. And that can unfortunately be a lot of people.

Author: M.L. Humphrey

I'm a former securities regulator, registered stockbroker (although only briefly), and consultant on regulatory and risk-related matters for large financial institutions with expertise in the areas of anti-money laundering regulation, mutual funds, and credit rating agencies. Since 2013 I have also been a published author who writes under a variety of pen names across non-fiction, fantasy, and romance.

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