Curtin's Tim Atterton presents the folly of price cuts.
We are, of course, fortunate for so many reasons to live and operate businesses in Western Australia. Not least because of the enviable lifestyle that we enjoy, and the high levels of economic growth the state has experienced over the past few years.
It is sobering, however, to consider some of the more paradoxical aspects of our business environment, and the implications of these factors on our commercial operations.
In Australia, 90 per cent of the population lives on 3 per cent of the land area. We have the eighth highest GDP per capita in the world, but the trade profile of a developing nation that exports primary goods and imports manufactured goods.
Perth is the most isolated capital city in the world but ranks high in the league table of high net worth individuals and disposable income.
These paradoxes continue into the entrepreneurship arena. The Global Entrepreneurship Monitor, produced jointly by London Business School and Babson College in the US, and supported by Swinburne University of Technology in Melbourne, ranks Australia as the eighth “most entrepreneurial” country in the world in terms of business formation and the number of businesses that are less than four years old.
The same commentators are highly critical of our ability to nurture and grow these enterprises beyond a micro base, observing that: “Australia needs to face a very unpalatable fact… we are a nation of quiet under-achievers … the businesses created by our entrepreneurs are not growth orientated … a bad situation shows some early signs of getting worse … [we need] to arrest early signs of entrepreneurial decline.”
Perhaps largely due to our isolation, WA is regarded as one of, if not the, most entrepreneurial state in the country. We have one business for every seven adults in the working population, compared with a national average of one to eight.
Yet, we have far too few high-growth businesses run by high-profile, entrepreneurial heroes and role models.
So, why do Australia’s fledgling businesses struggle to grow? Many don’t wish to, and are lifestyle businesses content to maintain their operations at a modest and manageable level.
But others are frustrated in their growth ambition. It is tempting to attribute their lack of growth entirely to the fact that there are too many businesses in a small, remote and isolated market.
In addition to a range of other macro factors contributing to our less-than-dynamic performance in the entrepreneurial growth stakes, a more localised, phenomenon lurks within our independent, business sector – sometimes called the ‘Perth disease’.
The major symptom of the Perth disease is the overwhelming desire to cut prices or offer discounts with a view to generating additional turnover. It is characterised by the willingness to sacrifice margin to grow a business based purely on volume, in a market sadly lacking in real volume.
This is a hugely flawed strategy that is beset with problems; the inevitable consequence being the erosion of real profitability as turnover increases, and a parallel increase in working capital requirement.
It is amazing, and worrying, to observe that Perth-based businesses often lose much of their profitability once their turnover grows beyond a $1 million-a-year threshold.
Competent business advisers are aware that a substantial ‘war-chest’ is required for this strategy to succeed, which is inevitably lacking in most embryonic businesses.
In this respect, credible advisers counsel vehemently against the dreaded ‘busy fool syndrome’, whereby businesses find themselves working harder to make less money, but are often ignored.
For example, a 10 per cent price reduction by a business aspiring to a 40 per cent gross margin imposes the necessity to increase sales by 33 per cent to be no worse off.
Of course, these additional sales need to be maintained over time, funded, and all other quality standards maintained, often with limited if any additional resources.
The underlying reasons behind this tendency to try to grow businesses on a strategy of price-cutting or discounting extend beyond the existence of too much competition and lack of market size. It is driven by an absence of international competitive forces that encourage operational efficiencies and lean management techniques and, thus, improve margins in other parts of the world – and, perhaps, a strong off-shore influence that promotes a ‘pile high, sell cheap’ methodology.
International evidence suggests strongly that truly excellent, independent growth companies are differentiators rather than price leaders and only seek new customers of the type that they want. Specifically, they maintain high gross margins during periods of growth and never sacrifice their price premium.
The worst thing that any business proprietor can do in response to poor sales performance in a relatively small or depressed market is cut prices with a view to building sales volume. This action merely raises the break-even point of the business and imposes an imperative that additional sales are required to cover fixed costs. In effect, price reduction or discounting in a small or declining market is a strategy that can only make a difficult situation worse.
• Tim Atterton is director of The BankWest Entrepreneurship & Business Development Unit at Curtin Business School, and chairman of the Small Business Development Corporation, WA.
