From the April 2002 issue of Entrepreneur

In 1998, VC-backed online DVD retailers had slashed prices to as much as 50 percent below retail. Not good news for 28-year-old Jeff Rix, who started DVDEmpire.com in 1995 in Warrendale, Pennsylvania--long before the price wars--with just $6,000 and a business model that called for pricing just 20 percent below retail. Online DVD retailers, including Rix's 42-person company, were buying DVDs for no more than 35 percent off retail. "The [other companies] were losing money on every transaction," Rix says.

Rix couldn't go as low as his competitors and live, but cutting profits almost to the bone, he reduced prices to 30 percent off retail. That made him one of the highest-priced DVD retailers, but by concentrating on service and surfing the surge in DVD sales, he kept growing despite the markdowns by deep-pocketed companies like Amazon.com, DVD Express and Reel.com.

In the end, he triumphed. One morning in 2000, Reel.com stopped selling DVDs direct, and then DVD Express shut down. "Then," Reed recalls, "everyone raised their prices." Today, Rix has raised prices back to 20 percent off retail, but that now makes him one of the lowest-cost online DVD sellers.

Even today, entrepreneurs constantly find themselves in positions where they'd like to play with prices. One technique causing a bit of an e-commerce controversy is variable pricing. This tactic, also called dynamic pricing, has long been accepted in retail stores, says Larry Compeau, associate professor of marketing at Clarkson University in Potsdam, New York. Even within a chain, prices are often higher in affluent neighborhoods, he says. But it's different online. In 2000, Amazon.com refunded customers who said they were charged differently for identical products depending on what Internet service provider or what Web browsers they used.

Amazon denied using pricing based on demographics and says it has ended what it called "pricing tests." But the reaction put customized online pricing on thin ice. Changing prices based on customers' ethnicity is already considered unethical; charging different prices to different B2B customers is usually illegal. Technology allows online customers to spot customized pricing, and their complaints will be heard, Compeau warns. "At some point, the government will have to get involved and say this is a legal practice, or it's not," he says.

Surcharges are another pricing tool. Last summer, some businesses used energy surcharges to counter surging electricity costs. Such add-ons let businesses raise prices while putting the blame on someone else--in this case, energy suppliers. However, the practice put off many customers. In California, reaction was so negative that some businesses began advertising "No Surcharge" to lure customers.

Surcharges do have uses, though. Because you can add or remove them without actually changing prices, they allow you to test new market positions without committing yourself.

Online price comparison also plays a role, but how much of one? "Some [consumers] won't bother," Compeau says. "They'll just go to their favorite site and buy. Entrepreneurs are quick to think they have to be competitively priced, but they may not have to." Service, selection and customer relationships are still important and, in many cases, more important than pricing.

Entrepreneurs should focus on value more than price, says Thomas Winninger, a Minneapolis marketing consultant and author of Full Price: Competing On Value in the New Economy (Dearborn). You can change value by adding or removing features, warranties and other products and services without touching the price, he says. You can also change prices to attract customers while changing value to maintain profit margins-especially important in today's economy. "Any time you reduce price, you're taking from the bottom line," says Winninger. "You can't afford that right now."

Rather than just dropping prices, position yourself as a partner as opposed to a mere vendor. For example, says Winninger, if you sell chainsaws, throw in a pair of protective goggles. When money is hard to borrow, offer zero-interest financing. In an uncertain world, being seen as an ally is more important than being seen as a bargain, Winninger maintains. "The customer is not out there trying to beat people up for prices," he says. "They just want to feel that whoever is selling is helping [them]."

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