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An old joke: A store owner purchases pencils for 10 cents a piece, then turns around and sells them for only a nickel. Noticing this bizarre behavior, his partner asks, “How do you expect us to stay in business that way?” The man replies, “Volume!”

Surprisingly, many novice entrepreneurs choose a similar strategy. They think they can succeed merely by pricing their products or services cheaper than the competition. Low prices, they assume, will generate sufficient sales to more than make up for smaller profits. Like the store owner of the joke, these entrepreneurs rationalize, “What I lose in margins, I’ll make up in volume.”

Competing on price is riskyCompeting on price is risky. Yes, some big businesses — and perhaps your local discount dry cleaner — seem to thrive on low prices. But low prices means narrow profit margins, and narrow profit margins means less cash floating around your company. With a small financial cushion, you’re vulnerable with every slight increase in costs. The landlord raises your rent 5%? That may be your entire year’s profit.

That, in turn, means you’ll have to find ways to reduce costs. The first thing you’ll be tempted to do is reduce wages and benefits. Watch out! This means you won’t be able to attract good employees. They’re less likely to be productive or loyal. You’ll be busy keeping an eye on them, and they’ll be keeping an eye on the clock.

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