Adam Smith writes that the price of commodities resolves itself into one or other of three parts: wages, profit and rent. ‘Wages, profit, and rent, are the three original sources of all revenue as well as of all exchangeable value. All other revenue is ultimately derived from some one or other of these’.
DEFINING IDEA…
Differentiate your products, provide great service and don’t even think about trying to compete with Wal-Mart on price.
~ MICHAEL BERGDAHL, FORMER WAL-MART EXECUTIVE
To make money, something has to be sold - what, how, when, where and for how much is all part of the business puzzle. Price, therefore, is a large part of that puzzle and getting it right is essential to success. When working out the price of goods or services, the merchant must take into consideration all costs associated with its creation, including the wages of labour to make it, the rent of any land or buildings where that item was created and the level of profit he or she wishes to make.
These issues now come under the topic of competitive strategy. And in modern business it is leading authority Michael Porter, professor at Harvard Business School, who has put business strategy firmly on the corporate board table. Porter offers three generic strategies for gaining competitive advantage relating directly to what Smith talks about regarding price:
• Cost leadership - be the lowest-cost producer because buyers like a bargain
• Differentiation - be different so you can justify higher prices
• Focus - target your offering to a niche group.
If you decide to target your product or service, you must also consider the first two points and decide whether you will compete on price or difference alone. Competing on price has made many people rich, but it requires economies of scale that few enjoy. It may be possible for Wal-Mart or Tesco to drive down supplier costs but not everyone has that sort of muscle. Therefore, it is wiser to compete through differentiation and focus.
Smith points out that not everyone making money is selling a product or service: there is also a very lucrative business in money. Interest is the compensation paid to the lender, ‘for the profit which he has an opportunity of making by the use of the money’. This additional ability to make money is at the heart of a capitalist, free market system. Those with money have always lent it to those who don’t have it, but need it to take advantage of business opportunities. Over time, this process has created banks. Like them or loathe them, they are essential for the global economy.
Smith warns, however, ‘The interest of money is always a derivative revenue which if not paid from the profit must be paid from some other source.’ He also advises that borrowing to pay off other debt is a recipe for disaster.
HERE’S AN IDEA FOR YOU…
Competing on price alone is a dangerous strategy, especially when the economy contracts. If you have a new product or service, test the price with your market before launching it. A great way to do this cost effectively is to use pay-per-click advertising online. Create alternative prices and test the response - you may find that sales are not affected by price as much as you imagine. Find out, don’t guess, what the market will bear!