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Should My Business Negotiate on Pricing

Q. Many prospective customers expect to be able to negotiate the price down before signing a contract. Should we negotiate price?

A. The answer depends on you and the circumstances in your industry. In some industries, customers expect to be able to negotiate. For example, most people who walk into an automobile dealership expect to pay less than the sticker price. Similarly, very few college students pay full price. Almost everyone receives a scholarship or loan of one kind or another. In these two situations and many others, competitors deal with this reality by building negotiating room into their pricing structure.

Car dealerships expect to negotiate, so the sticker price allows them room to offer discounts and still make a profit. Colleges and universities plan to offer discounts as well. In many cases, the average student pays less than half of the stated cost of tuition, fees, room and board. Yet the schools manage to keep their doors open.

One way of dealing with customers who expect a discount is to build negotiating room into your price structure. A benefit to handling the issue in this way is that not everyone will attempt to negotiate. Some people will pay the higher asking price, which will increase your profit. Conversely, you may not wish to negotiate with some customers. Perhaps you know that serving some customers is more expensive. In those situations, you can reduce the amount you discount.

There are some downsides to this approach. Some people may be scared off by your higher asking price and not even bother to negotiate. Additionally, some customers simply do not like to negotiate. They will make a decision based on the best asking price they find. If you have built too much headroom into your pricing structure, you’ll miss out on this business. Of course, some business owners don’t enjoy negotiating and choose not to do so.

In some industries, this has led to a preemptive strategy called the “no dicker sticker.” In other words, business owners let prospective customers know up front that their asking price is firm and they will not negotiate. CarMax is well known for following this approach in the pre-owned vehicle industry. This avoids all of the disadvantages of negotiating price, but has some drawbacks of its own.

If most in your industry negotiate price and you don’t, you’ll establish the target. Unless you have a much lower cost structure than your competitors, they’ll always be able to price slightly below you. Therefore, you’ll need to differentiate your product or service so that customers are willing to pay your higher price.

In some industries, refusing to negotiate can result in adverse selection. That is, if not all customers are created equal, having one fixed price can result in you ending up with more unattractive customers and fewer attractive customers.

Consider colleges and universities. Academically stronger students are more desirable that their weaker peers. If a college were to offer its average price across the board, the academically stronger students would go to other schools, which offered them more scholarship money. The academically weaker students would find the average price to be better than what they could get elsewhere and would attend. Adverse selection would mean that schools who have only one fixed price end up with fewer academically strong students and more academically weak students.

If some customers are more attractive than others are, adverse selection will force most competitors to differentiate price by customer. In other industries, the choice of whether to negotiate price is up to the business owner. You can try both strategies to determine what works best for you.

Next week we will share strategies for successful negotiating.

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