I am in the camp that believes less revenue with higher profit margins is better than more revenue with lower profit margins. Less revenue means less transaction costs, less re-ordering, less customer service, less payroll, less headaches, etc.
It's very likely that for all but the biggest companies truly differentiating economies of scale are not achievable. Being a $5 million dollar online retailer versus being a $20 million dollar online retailer is not that different in terms of what kind of systems you can afford. Chances are the systems that you will be using aren't that different at all. So you achieve some savings unless your systems are priced on a pay for what you use model. But it's not that big a difference to provide a sustainable competitive advantage.
Being a 1 billion dollar retailer, though, should allow for the kinds of investments necessary to achieve a decent scale. But again even a 1 billion dollar a year retailer can't afford to keep up with Amazon.
Since scale isn't a good reason to have higher volume at lower prices per item, let's think about some other reasons you might opt for higher revenue and lower margin:
- Vanity: No one ever asks "how much money did you keep last year?". They might ask how much your top line revenue is or how many orders you ship per day or how many employees you have. So it feels better to say we are a $10 million dollar retailer than a $3 million dollar retailer.
- Clout with Vendors: Our vendors sell to large companies like Target, Urban Outfitters, Hot Topic, etc. We are so far away from these companies in terms of importance to our vendors that the best we can hope for is to be their favorite web only retailer. It's like being the best player on a college intramural team. You are only good if you limit the comparison to a small bubble. The point? Chances are you aren't going to get that much better treatment until you are a really big company.
- Growth: It feels much better to be a growing company than a shrinking company. Can't argue with that sentiment. But if you are creating growth that isn't profitable you are just "trading dollars". Revenue growth is awesome, but only if profitability stays about the same. Would you rather have a $20 million revenue company with $1.5 million in profits or a $3 million company $750k in profits?
So how is all this about higher pricing? All things being equal, a company with higher prices will sell less than a company with lower prices. That doesn't mean revenue will be less, just that more items will be moving in and out the doors. But there are so many costs associated with taking even a single order that I believe you are better off with slightly higher prices than your competitors, here are some reasons:
- Transaction costs are a bitch. I tried to compete with some Amazon sellers by looking at items doing well there, buying them in bulk to get great pricing, and then being the low price leader. But the problem is that handling a t-shirt costs the same whether I get $13 or $24.95 for it. So even though paying $5 for a shirt and selling it for $12.95 leaves with me a gross margin of 60% I only have $8 in actual gross profit. Subtract these costs: ordering, inbound shipping, receiving, picking, packing. What are you left with? Not that much.
- Price shoppers have higher transaction costs. Not only do these people place a higher value of their money than their time, they place a higher value on their money than your time too. I've seen price shoppers do things that make zero sense. I'm talking sending back an item that they paid $4 for and paying the shipping to do it. Maybe this customer cleared $0.30 on the refund.
- Price shoppers are loyal to price, not to you.
- While the 3 bullets above I am confident describing as facts, this one is an observation that may be clouded by me choosing to notice what low price customers do. It sure seems, though, that the more someone pays for an item the likelier they are to be happy with their purchase, to write a positive product review, to be nice in their emails or phone calls, etc.
- Gift givers don't want to be cheap. Most people want to think of themselves as generous when it comes to giving gifts. Pricing too low can send a signal that the product isn't good enough to be given as a gift.
- Higher prices = higher perceived value. There is a ton of psychology in pricing. Having higher prices can work to your advantage in this regard.
There are too many good reasons to maintain healthy margins and too few to try to win a price war. Keep transaction costs in mind when selling lower dollar items because what looks like a healthy gross margin percentage can evaporate once transaction costs are considered.