The trouble with low prices

iStock Joe Potato

Failing to invest in upkeep is a recipe for future problems

By Steve Martin

There are numerous ways that success is measured within a business. Gross sales, customer satisfaction, happy and fulfilled employees. Just simply the good feeling that comes from knowing you are providing a needed or wanted service to those around you. These can all be good reasons for pressing on in a business venture. The bottom line is an important factor as well, at least for the long-term preservation of the business.

There is another component that I think is important which I have rarely seen addressed. It might not be foremost in people’s minds, especially during a possible recession or at the beginning phases of starting a business. But I do believe that recognizing this important element can help one in making some important decisions along the way. I am talking about the eventual saleability of the business itself should you ever wish to sell it.

Have you ever dealt with a company, possibly even a well-respected company that has been in business for many, many years, who gives exceptional service at lower-than-average prices, and wondered how they were able to do it? I can think of at least two restaurants in Waterloo Region that fit this classification. They have these things in common:

  1. They have been in business for over 50 years and been owned by the same owner or family all that time.
  2. The quality of their food and service is very good, consistent and has changed little over the years.
  3. Their prices, while not dirt cheap, are well below what you would normally expect for their level of food and service.
  4. They have spent very little on their premises over the years. While clean, they could best be described as dated, perhaps even a little bit shabby.
  5. They spend little on promotion, probably because for the last 30 years they have not needed to.

So, what is the problem?

I see these companies as dead-end companies. If the owner is aware of this, their end game is to run the company until they either die or retire and then let the company die after them, there is nothing necessarily wrong with this approach. After all, if they are still making an adequate profit, even if it might be smaller, but it is enough to live on and their customers are happy, so be it.

The complication arises if their intent is to eventually sell the company, or even if they plan on carrying on the business to the point where the shabbiness becomes too much and major capital needs to be invested to restore it. Now we have a problem. Anyone that wishes to purchase the business is going to have to lay out sizeable capital just to buy it, let alone do the repairs that will have to be done. The only way to get a return on that investment will be to raise prices. Guess what will happen if they raise prices?

Even if they maintain the same quality of service and food, many clients will leave because they will perceive the new owner as being greedy. After all, the old owner was satisfied with less, so why the change?

Over time, the old owners took on a clientele that largely went there because of the price. So price becomes a very big deal.
These customers will not take kindly to a sudden increase. What is interesting is that the old owners did not necessarily start out being cheap. They paid off their debt and then failed to continue to factor in a return on the investment of their growing capital assets. This is a common mistake companies make because it is often an easy way to compete with newer competitors that do not have that luxury.

It becomes even more tempting to do this when there have been long periods of very low interest rates and the case can be made that the money one gets from selling one’s capital investment would not return much anyway. In the long run, this is a dangerous way to do business. I would refuse to buy a business that was not factoring in at least a small amount of return for the capital portion of their assets.

Be careful, even in the case of a merger, where you may be buying a business similar to your own. I know of one case where this occurred. A much larger business bought a small- er business that had run successfully for years as a family business. But they had kept their prices low by simply not doing anything but the bare minimum in maintenance. Guess what? That division failed in less than five years for all the reasons I have enumerated.

Most people blamed the new owner. I would argue that even if the old owners had kept the place, they would have had to spend millions to bring it up to spec, which would have necessitated a sudden increase in price. This could have been avoided had those increases happened gradually.

An aside regarding promotional spending … there can be very good reasons not to spend on promotion. For instance, you are busy and are running at capacity. Why spend to promote? All I will say is to be careful. Look carefully at your customer base. If your clientele is largely 60 and older, you may have a big problem on your hands in a few years. In a world where people move around more than ever, you cannot assume that their children will be around to take it up when they leave.

I recognize that often when a business starts out, the furthest thing from the entrepreneur’s mind is the reselling of their business. This is especially true when a person is young and healthy and appears to have a long life ahead of them. For some, the very idea that someone else will take their baby that was grown through blood, sweat, and tears is almost revolting. For others, it is simply assumed that a child will carry on where the parents have left off.

Even if that is the plan, it is a good idea to ensure that prices reflect the future needs for capital improvements. Gifting the business to one child when there may be other heirs involved can create its own set of issues. My advice is this. While it may be the easy thing to do, keeping prices low is probably not a good move if you take the business’s longevity into consideration. If an owner’s intention is to dissolve the business when they get out and simply sell the real estate as a separate entity, the above advice may apply to a lesser extent.

Even then, though, a person might want to take into consideration the overall impression he is leaving with the consumer that will think that his competitors may simply be greedy for needing to charge more. As in most areas of life, looking at our present-day actions in light of how they will affect the future is always wise.

Steve Martin is a retired businessman who worked as retail sales manager for his family’s business, Martin’s Family Fruit Farm, in Waterloo, Ontario


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