Does It Pay to Cut Prices?

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By Rosalind Resnick

Opinions expressed by Entrepreneur contributors are their own.

With everybody from Starbucks to Apple cutting prices during the recession, it's little wonder that small businesses are feeling pricing pressure, too.

But, if your business needs a pick-me-up, does it really make sense to cut prices or offer discounts at a time when your customers may not be in the mood to buy? Before you pull the trigger on your pricing gun, step back and ask yourself these questions:

•Do you know how much money you make on every sale?

Mostbusinesses focus on two metrics--sales and bottom-line profits--to gaugetheir financial success. By contrast, gross margin--the ratio of gross profitto revenue--measures your company's efficiency in turning raw materials into sales. Think of it like this: For every $1 of sales that your company rings up,how much money do you have left over after buying the materials and othersupplies necessary to make your product or provide your service? If the answer is50 cents, your gross margin is 50 percent. If your prices aren't high enough to allowyou to maintain at least a 20 percent gross margin on every sale, it's unlikely thatyour business is going to be able to clear much of a profit after yousubtract rent, payroll, insurance and other fixed expenses.

•Do you have "people costs" you need to cover?

Justbecause you've got a gross margin of 50 percent doesn't necessarily mean that you'remaking a healthy profit. That's why your pricing needs to reflect your totalcost of doing business (not just your cost of goods sold), which, in many cases, can be muchhigher. Don't forget to factor in the "people" costs--the admins, sales reps, production staff, contractors, etc. who do the work that makes your company tick. Before you cut your prices, rememberthat you need to pay these people, too!

•Do you need to pay to bring business in the door?

Ifyou run a restaurant or retail store, customers walk in the door and you don'thave to worry about paying for sales leads and referrals. But that isn't trueof a manufacturing or service business in which small businesses without their ownsales force rely on the Internet or on independent reps or agents to bring them customers and orders.Depending on the industry, these reps can charge commissions as high as 20 percent onevery sale. Web traffic isn't cheap, either. That's why, if you needto rely on third parties to help sell your product or service, it's importantto build in enough margin to maintain a distribution network and still make a profit.

The bottom line: If you've got a good relationship with your customers and sella specialized product or service that the market wants and needs, you should try to find a way to hold the line on prices without losing business--and build a solidfoundation for your company's future. If not, it may be time to go back to Starbucksfor a $2 cup of Joe.

Rosalind Resnick

Rosalind Resnick is a New York-based freelance writer, entrepreneur, investor and author of The Vest Pocket Consultant's Secrets of Small Business Success.

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