Low Prices Are Not Always Your Friend

Cutting prices might seem reasonable given the state of the economy, but doing so could backfire over the long run, argues our columnist

The economic news has not been good of late, and that may lead you to believe you should find a way to lower your prices. After all, consumers will be looking for ways to cut back. But while lower prices may make sense from a short-term perspective, they may not be as strategic as you think. Let me explain.

The other day I saw an ad for a convenience store trumpeting the virtues of its affordable, freshly brewed coffee. The headline said "Because your morning coffee shouldn't cost more than your lunch." The obvious dig at Starbucks (SBUX) made me chuckle.

But it also made me think. Why shouldn't it? Is paying $3, $4, or even $5 for a cup of coffee really so irrational? Perhaps so if all you're buying is coffee, but if along with it you enjoy a relaxing, pleasant experience it may be quite a bargain. In today's fast-paced culture, how much is 10 minutes of bliss worth?

Price as an Indicator of Value

That thought reminded me of another shopping experience, this time revolving around jewelry. I recently inherited a ring from my grandmother that was somewhat dated, but featured a beautiful aquamarine, my wife's birthstone. I knew she would love the stone, so I set out to find a jeweler who could redesign the ring into a pendant in time for her birthday.

I visited three or four different jewelry stores, trying to find one that would offer design talent, a personal touch, and a willingness to work within my budget. And as I evaluated my own decision process, I observed something interesting and somewhat surprising—I gravitated toward the most expensive option.

I can't say that the jeweler I chose was definitively better than the others, but for some reason I felt more comfortable with it, not in spite of its higher prices, but because of them. I felt that by paying a little extra I would be more assured of ending up with a piece my wife would love.

These are good examples of how price is a product feature (BusinessWeek SmallBiz, Winter, 2006), regardless of whether it's intended to be. For all I know, Starbucks might use the same coffee beans as the convenience store, but its higher price suggests a more valuable blend. The gold and diamonds my chosen jeweler sells may be identical to those found at other stores, but the fact it charges a little more gives me the sense that the quality of its work is better. Both are rational conclusions for me to draw, because thousands of previous purchase decisions have taught me price isn't merely a reflection of product quality, it's an indicator of it as well. If something is more expensive, it's usually for good reason.

For Long-Term Success, Higher Prices

Say you were in an electronics store evaluating two TVs that had similar features and design characteristics, but were significantly different in price. Which would you choose? Many people would choose the lower-priced option, but some would go with the more expensive model. Would the latter group be acting irrationally? Not at all—even those who bought the cheaper TV would most likely agree the more expensive option is somehow of higher quality. It would have to be (goes the reasoning) to justify its higher price.

Higher prices may lead to lower sales volume in the short term, but they also provide the margins companies need to invest in brand-building or to expand their distribution networks. The chief executive of national chain Ultimate Electronics serves as the company's spokesperson, and in his advertising he insists Ultimate always has the lowest prices. He boasts they continuously shop the competition, and when Circuit City (CC) or Best Buy ( 2 Next Page

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