Q: Is it better to underbid the competition and not make much money on an account, or price for quality service and be more selective?
Tony Mena, Homeland Security Protective Service
A: Great question that pulls together accounting, microeconomics, marketing and management.
Accounting (first step): What are your costs to serve each account? Look to see which costs are variable. That is, if you did not have that customer you would not have those costs. Personnel or hours worked on a specific account, or mileage driven on behalf of that account, are probably the most obvious examples. Equally important, what are your fixed costs and how are they allocated to a specific account?
Microeconomics (second step): In the short-term (generally under one year), your company should produce as long as all variable costs are covered. Once you cover your variable costs, the additional dollars you earn go to covering your fixed costs. Now in the long-run (over one year) all costs, both fixed and variable, must be covered but the argument or logic to price your services below your average variable costs does not make sense. In a given week, for instance, you could be receiving revenue below your average variable costs to maintain an account or deal with a special circumstance, but I am hard pressed to see the logic in this.
Marketing/management (third step): Can you deliver the anticipated services at a price below what your competitors will charge? If the answer is yes, then you can underbid them. But look back to step 2 on a regular basis to confirm that you are covering both your fixed and variable costs.
As your question implies, there is no point in "buying business" by underbidding the competition for business that you cannot profitably sustain. If you cannot be the low-cost competitor, you can look for customers who value a higher-quality service, but you must provide a sufficient point of difference — a reason to use your company — to justify a price premium.
Don't shoot the messenger. The sales force must be provided with the tools (step 1) to identify customers who your company can profitably serve, and be incentivized to identify, secure and keep profitable customers.
Jonathan Seltzer is a professor of marketing at the University of St. Thomas Opus College of Business.
