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Cashflow

Undercharging is immoral

Small to medium sized business owners generally fear undercharging, more than they do overcharging. But the risks with undercharging are more severe and can lead to business failure over time.

RightWay

Jan 19, 2021

Small to medium sized business owners generally fear undercharging, more than they do overcharging. But the risks associated with undercharging are more severe and can lead to business failure over time.

It is pretty standard for business owners to be hesitant to increase prices. Generally, it is the fear of losing the work or sale that creates this hesitation. In some cases, the argument is that charging more feels immoral – that pricing higher could lead to excess profits which might not be viewed as being “fair”.

But to my mind, it is more immoral to run a business with little to no profit, than it is to run a business with excessive profit - it is relatively easy to run a business with little profit after all.

For example, imagine you start a food truck selling burgers for $1 each. Given the exceptionally low price point, customers flock to the food truck and you are crazy busy. Given how busy it is, you start patting yourself on the back for winning the customers and growing the business. Within a couple of weeks all your cash is gone however, and you have to sell the truck.

This is an extreme example but it highlights what can happen to a small business that undercharges. Even being 10% below the industry average can cause cash to run dry over time.  

The consequences of undercharging include not having enough money to pay your taxes, getting into debt, and not having enough money to sustain your living costs or that of your family. In some cases, it means that other business owners also suffer if you can’t pay supplier bills. Your competitors can look at your price point and try to match it, leading to a race to the bottom. This has a ripple effect the reverberates around the economy.

By comparison, the risk of overcharging is that you have to work a bit harder to find profitable sales. Unprofitable sales are easy to find, but to find a good profitable customer or sale is a challenge, and rightfully so.

My general rule of thumb is small to medium sized businesses need a gross profit margin of 30% to be sustainable. Selling at a lower price point than that isn't a good idea. This of coarse depends on the specifics of the business – but I find almost always where gross profit is less than this, there are generally cash flow problems and it can come to a head at tax time, regardless of how much time you have had to prepare for the taxes.

When a business fails this has a massive impact on a range of people - staff lose their jobs, suppliers might have to retrench, and the impact manifests itself in financial hardship for real skin and bone human beings. It is immoral to run a business to the ground because of the way that impacts people.

Putting up your prices might mean less sales to start with, but you will be more profitable on the sales you do achieve. And over time, there is no real barrier to finding profitable sales – it just takes more effort.

This is a mental shift that all who transition from consumer to successful business owner must make. A consumer is generally obsessed with finding the best price, depending on their life experience with money. But regardless, a business owner has to transcend their individual attitude and feeling toward money – and see the objective truth, that the business must be profitable enough in order to survive.

For a small to medium sized business, competing on price is a fool’s game. Unless you have the volume of McDonald’s, selling burgers at $1 will never lead to good financial outcomes. Analyse your competitors pricing, find the mid-point, and make sure your pricing is somewhere above that.

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