Sometimes never compete on price

source

“Never compete on price.”

So we are told. But customers like low prices, and it worked for Costco, Southwest Airlines, Vanguard, IKEA, Amazon, Walmart, McDonald’s,, H&M, Dollar General, TJ Maxx, and many others. So why are we told not to use a low-price strategy?

“Never compete on price”

When two products are fundamentally different—in features, integrations, and complexity—customers often have no real choice between them. An Enterprise must use software with single-sign-on, security controls, compliance features, and scaling to thousands of users with roles and permissions and integrations with corporate systems.

For a small business, those features make the software harder to use. And they don’t want to pay for things they don’t need. So Enterprise- and SMB-targeted products compete on capabilities and user-experience, not price. The Enterprise cannot use the cheaper SMB version.

But consider two products that are functionally identical. They solve the same problem in the same way, with mostly the same features. The sales teams highlight minor differences that matter to maybe 10% of users. Because they’re essentially the same, price is only differentiator left. They are two gas stations across the street from one another; the main difference is the big sign with numbers on it.

When one drops prices by 20%, they start winning market share. The other, having no other way to compete, does the same. This continues through “special offers” and permanent cuts until there’s no profit left. Both companies end up poor, unable to invest in product development, marketing, or customer service. The products and companies deteriorate, which in turn degrades the customer experience. Low price come at a price after all.

The math is worse than you think. A 20% price cut needs a 25% customer increase just to maintain revenue.¹ It’s asymmetric and working against you. It’s worse again when you consider the effect on profit; even a seemingly-minor 10% price reduction could mean a 50% profit reduction²—terrible!

¹ Making 80% of the money off 120% of the customers multiplies to 96% of the revenue you had. Percentage losses always require even-larger-percentage gains just to get back to where you were. This effect applies everywhere, such as how to become more productive.

² Suppose the company charges $100 for a product and makes $20 profit after all costs. Reducing the price to $90 (i.e. a 10% price reduction) reduces profit to $10 (i.e. a 50% profit reduction). This is exactly why established companies cannot compete on price, and thus that is their Achilles’ heel.

So indeed this isn’t an issue only for “shareholders” or SaaS metrics buffs. It means the company cannot fund things like product development, or better marketing, or talent in tech support. That in turn means the product is worse, the service is worse, and the company is worse. Ultimately this is bad for customers, employees, and founders. And, sure, also shareholders.

So, is it true? “Never compete on price?”

Well, not exactly. We have counter-examples.

Of course it can be an excellent strategy to have the lowest prices. There are many examples of wonderful companies, with amazing products and happy customers, and even happy shareholders, where “low prices” is critical to the successful strategy.

Jeff Bezos famously quipped: “Your margin is my opportunity.” Meaning, while a competitor is taking profit from a product, Amazon will sell it cheaper, which either means stealing market share (if that competitor stubbornly maintains its price) or destroying the competitor’s profit (if that competitor matches Amazon’s price).

But isn’t this just restating the problem we just outlined? Why is this smart for Amazon, but dumb for that other competitor?

Low price as a strategy

The difference with each of those companies who successful competed using low prices, is that the price was part of a comprehensive strategy to win, with unique, interlocking, self-reinforcing decisions, where “lowest price” was an outcome of the decisions, not a tactic thrust upon them by the competition, not the last tool they had remaining to win a sale.

Those same decisions created products that were actually great, that consumers actually wanted, as opposed to weak, undifferentiated products where price was the only dimension left to compete on.

Finally, those decisions created negative consequences also. They are trade-offs. While they create greatness in some areas, they create weaknesses in others. Not all customers want that trade-off; those will not buy, or at least not willingly, and will be happy to switch to a competitor who makes a different set of trade-offs. That’s OK; that’s the price of a great strategy, and a great product; the alternative is a weak product that no one is excited to buy.

Some case studies:

source

Costco

By coupling higher quality products with higher quantities in each purchasable package, the unit price is lower than grocery stores. Consumers would be thrilled to get a deal for something “this good.” A store that caters to bulk-buying could also get away with a “warehouse” feel, and not stock all the goods that a daily grocery store might; this gives them more inventory flexibility and they can spend less on the interior; lower costs yields lower prices while also yielding profit. Because other grocery stores couldn’t match it, their stores were unique. Then they added the requirement of an annual membership; pure profit, and increases how often a consumer comes back to the store.

Furthermore, the store has a strict 14% margin cap on all products. Other retailers might aim for 25% or even 50%. This limits profit-per-item—clearly a financial penalty, especially when customers would be willing to pay more—but again this interlocks with their brand promise of always being inexpensive.

Defying more industry “wisdom,” Costco is always well-known for treating employees particularly well, including an average $24/hr wage for roles that are paid half that at other grocery and retail stores. This decreases turnover and increases productivity, which again contributes to profits and a great customers experience. If only all grocery stores would realize the wisdom of this strategy.

Thus, interlocking decisions about quality, package-sizes, inventory, store-constructions, and membership, yields “low prices” as a result.

source

Southwest Airlines

Southwest Airlines has been a powerhouse for 50 years, remaining profitable even during the US terrorists attacks of September 2001 and throughout the Great Recession of 2008, surviving COVID, across a period where every other major US airline filed for bankruptcy at least once. Yet they have the cheapest tickets.

Like Costco, there are interlocking product and operational decisions that makes their offering unique. They run back and forth many times per day along the same few, short routes. Already there’s a negative trade-off—no long routes, not international—but also positive ones—frequent flights means consumers have better schedules and it’s easier to “catch the next flight” if you miss on. Other airlines have many kinds of airplanes for many kinds of routes, but Southwest uses only one type of airplane; this gives them pricing power over the supplier (due to large orders), and is cheaper to maintain (mechanics need only a single set of tools, trained on only one type of airplane), naturally reducing costs that can be passed on as lower prices. They have no amenities—no 1st-class seating, no meals, no baggage transfers, no connections to other airlines—which again is a negative trade-off for consumers, but lowers costs and therefore allows lower prices.

This strategy was so effective—and so well-studied—that it gave rise to a whole sub-category—the so-called “low-cost carriers” that includes JetBlue, Spirit, and Frontier. None were as successful, and none impinged on Southwest’s profits, demonstrating that great strategy works even in the face of competition that is expressly “copying you” to replicate your success.

source

Vanguard Funds

Every large mutual fund conglomerate in the late 1970s had a business model with hefty operational fees that paid the salaries of fund managers and analysts, who actively researched stocks, picking when to buy and sell. Consumers were paying around 2% per year to have these managers vigilantly understanding and picking stocks on their behalf. So, if the fund increased in value by 5%, the consumer would receive only a 3% increase. It really hurts if the fund decreases in value.

Vanguard realized that many people might want a completely different product: One that simply tracks indexes like the S&P 500, or automatically (i.e. without human judgment) tracks well-defined sets of stocks like “Large American companies.” Without teams of human beings, they could eliminate the industry-typical 2% charge for management fees and expense ratios, replacing it with de minimus fees from the automatic trades. For consumers who believe that fund managers outperform the market, this new product was silly. But for customers who believe that managers don’t out-perform the market in the long run—especially after removing the compounding effect of fees—the Vanguard funds were uniquely low-cost. Again, “low cost” was an outcome of a unique product, that made different trade-offs, that was appealing to a subset of the market.

source

IKEA

IKEA revolutionized furniture retail with a comprehensive strategy where every decision reinforces low prices. The foundation: having customers assemble their own furniture.

This seemingly simple decision created a cascade of advantages—flat-pack furniture dramatically reduces shipping and storage costs, allows for more efficient store layouts, and minimizes damage during transport. Their unique showroom-to-warehouse flow, where customers navigate a single path through inspirational room setups before collecting their own items, both enhances the shopping experience and reduces staffing costs. Their long-term supplier relationships and enormous production runs achieve economies of scale that competitors can’t match. The globally standardized product line means they’re not creating custom products for each market. These decisions come with clear trade-offs—furniture that isn’t heirloom quality, the notorious assembly experience, and limited selection within categories—but for price-conscious customers furnishing their first apartment or dorm room or looking for trendy temporary pieces, IKEA’s system delivers remarkable value. The low price isn’t a tactic; it’s the natural outcome of a thoroughly designed business system.

Low-cost strategies don’t require excessive financing

The modern SaaS playbook suggests that raising tens or hundreds of millions in venture capital is necessary for low-price strategies. The playbook is logical. The theory is that low-price business models are only profitable at scale—to outgrow the overhead of people, to develop bulk discounts from suppliers, to amortize sales and marketing costs over enough customers, and so on.

Logical though it may be, it is not correct. All four of these iconic low-price leaders thrived with remarkably modest initial financing.

Costco’s first warehouse opened in 1983 at a cost of $5M, and went public in 1985 at a small $30M offering. Costco’s model was profitable almost immediately—the membership fee revenue alone covered most operating costs, allowing them to operate on razor-thin margins from the beginning. Their expansion was largely funded through operational cash flow rather than massive external financing rounds.

Southwest’s initial financing was remarkably modest for an airline. Founded in 1967, they started with $560,000 in initial capital from investors, including Rollin King, Herb Kelleher, and a small group of Texas business people. They began operations in 1971 with just three aircraft serving three cities. Southwest’s ability to turn a profit quickly allowed it to fund most of its expansion through earnings rather than heavy external financing.

Vanguard was created in 1975 as a client-owned company by John Bogle following an internal dispute within Wellington Management. Its initial capitalization was minimal - reportedly around $2 million. The unique ownership structure meant that it didn’t need to satisfy external investors seeking high returns. The index fund strategy required minimal operational overhead from the beginning - no teams of analysts, no expensive trading operations. Vanguard’s growth was organic and didn’t require substantial external financing rounds.

IKEA’s financing story is fascinating because it was almost entirely self-funded through operational cash flow. Ingvar Kamprad started with a small loan from his father to launch a mail-order business in 1943. The first furniture showroom opened in 1953, funded entirely from the profits of the mail-order business. IKEA’s rapid expansion globally was financed primarily through reinvested profits.

Remember, these are physical companies with materials, supply chains, inventory, and buildings. Software companies should be able to do the same with no more investment than this.

The common themes which allowed them to achieve this, besides the overarching theme of the interlocking, self-reinforcing strategy are:

1. Their business models were profitable from the early stages, not just at scale.
2. They had unique operational approaches that allowed for capital-efficient growth.
3. They prioritized reinvesting profits into expansion rather than seeking external financing.
4. They often started with narrower offerings or geographic footprints and expanded gradually.

This should give hope to bootstrappers everywhere, or folks wanting to raise sustainably-small rounds from strategic investors and advisors. However, remember that just having lower prices is insufficient—the entire low-price strategy must be in place.

When the only differentiation a product has is “it’s cheaper,” that’s worse than a bad strategy—it’s no strategy at all. The result is commoditization and a race to the bottom. That’s why you mustn’t compete only on price.

That’s cheap, not affordable. That’s a lack of vision, not a comprehensive strategy.

When lower prices are a result of strategy—business structure, cost structure, product trade-offs (that ICPs love but others hate), and other decisions that competitors can’t or won’t make, then low prices are a powerful, winning strategy.

Printed from: A Smart Bear
https://longform.asmartbear.com/never-compete-on-price/
© 2007-2025 Jason Cohen      @asmartbear