Inspired by Guy Kawasaki’s talent for identifying the “untruths” of the business world I thought I would try my hand at a few. The first on is the illusion of price erosion.
Prices do not erode! What erodes is a company’s ability to be more successful than their competitors at satisfying customers. So called price erosion doesn’t happen to individual companies, it happens to entire industries. When an industry experiences price erosion it is really an expression of the fact the players in the industry are achieving less and less diversification between themselves. When everyone offers what appear to be more or less the same products and services prices fall. Price erosion is only a symptom or evidence of the lack of innovation within an industry. Managers will sometimes justify lower revenue and weaker margins by proclaiming that they are victims of price erosion. You never hear them say prices are down to due their lack of ability to outpace their competitors!
Continuous improvement in value creation is hard. Lowering prices is easy! Most companies find themselves in situations where they are compelled to lower prices in order to maintain their customer base from time to time. Short-term profit margins can be maintained by reducing costs but long-term, the only way to earn more money is by creating more value for your customers. At some point in time you will reach a level of efficiency where cost reductions erode the value of the customer offer and only lead to further price reductions without additional margin. Many companies discover that although their margins are the same as a percentage they have declined drastically in real money.
If you feel compelled to talk about price erosion, make sure you keep in mind that it is only a symptom. If putting a label on the symptom helps you better understand the illness then power to you but don’t neglect the reality that your prices are eroding because your business is losing its competitive edge.
