The Plague Called Undercutting

[rivercrow]

I just got off a very interesting phone call from a company marketing training. Things were going very well--extremely well--until the sales person decided to show me the possible rates for consulting a job: $14- 45K. These are reasonable rates, given what I've seen and what my skillset is.

The sales person then suggested that I offer a low-end job at $8K or $10K.

I proceeded to explain to him why this was horrible advice.

Boys and girls, you never undercut. Charge according to an objective assessment of your skills and experience and factor in local conditions (different rates for not-for-profits, etc). Then stick to your guns.

Let's assume you and your peers are all of the same skill set and background. You undercut your peers to get a job. The next time that customer goes out to bid, there's an expectation regarding rates. You're going to have to fight for your rates.

Your peers will have to fight for their rates as well. Undercutting affects everyone in the community--so now you all have to struggle more. You're devaluing your skills and experience.

When you steal jobs, word gets out. Now your peers know who's undercutting. People in the same field will cross-refer work if they're swamped. Will you get references from people who know you undercut? Is greed and momentary profit a reason to set up bad blood in a community?

If you're a woman, you're already used to being worth 70-80% of a man while struggling just as hard to maintain and build skills. Why perpetuate this nonsense?

When I finished, the sales person admitted no one had ever explained why undercutting is such a dangerous practice.

Go on and argue free-market and price-fixing if you want. Undercutting is a plague.

[Geoff]

Agreed.

As a tax adviser, I am not afraid to charge what it is worth. it despairs me when people say "how will we recover the cost?" instead of "how much will you save me?"

-Geoff

[reason]

Wow, that's the single worst piece of advice I have ever read. Boys and girls, please undercut if that is your most profitable move i.e. you will not be hired unless you drop your price.

Imagine a world in which these principles were consistently applied. The economy would basically be composed of a great number of cartels, each charging monopoly prices. In the case of labour this is doubly tragic, since employers buy less at higher prices, which means fewer people are employed. This might provide job security for those already in the industry, but is detrimental to society.

Furthermore, don't believe that it is even possible to charge a price "according to an objective assessment of your skills and experience," since there is simply no such objective price that exists. No talent, experience, skill or knowledge is intrinsically worth anything to anybody, no matter how much time you may have spent perfecting it. The only question you need to ask yourself is whether you benefit from the exchange and if there are better alternatives, that's all.

The point that competitors may resent those who charge lower prices than them may be true, but hardly a adequate to prevent undercutters thriving, that is unless they manage to get their cartel endorsed by law. The fact is that the majority of the most successful businesses of the last century were so because they ruthlessly undercut competition. That is besides the ethical considerations of being a member of a cartel.

As for the comments about women, the facts when examined closely simply do not fit the myth, and it has precisely bugger all to do with undercutting in the first place. If you suspect that sexist employers discriminate against women, then the proposal to not undercut is even more absurd, since where everyone is charging the same price, employers suffer less costs when discriminating against women.

Finally, dismissive comments like, "Go on and argue free-market and price-fixing if you want. Undercutting is a plague" are not arguments, it is a substitute when one is unable or unwilling to face up to the consequences of their vision.

[rivercrow]

I have to disagree. I've seen markets dry up because of undercutting and consistently lower quality service. If you're selling a service, then quality is what you're marketing.

Is it more efficient to hire more slipshod workers or fewer skilled workers? I don't think so. You do that with software, and you end up with a product promising endless patches. Do it with auditing services, and you run the risk of missing regulatory compliance. How about legal services?

When I wrote this, I had in mind smaller businesses and consultants, rather than giant organizations. Hence my comments about consulting jobs.

It is possible to make objective assessments. How does anyone place a value on their work? If your work is not on par with that of your peers, then charge less. If the market only bears x, then x is what you charge. But if you promise a certain level of service and fail to deliver, you'll face the anger of your customers.

As for women. No, when I go for a job, I don't intend to undercut. I've been told sometimes that companies hire women because they're cheaper, but see who's in positions of authority. This kind of nonsense matters to me, since I am a female in a field that's 80-90% men.

It may be a dismissive comment, but I'm basing my observations on practical experience, not theory. In the end, what works and what I can live with are what matters.

[reason]

Originally Posted by rivercrow

I have to disagree. I've seen markets dry up because of undercutting and consistently lower quality service. If you're selling a service, then quality is what you're marketing.

No, first and foremost you are maketing the service, only afterward are you marketing the quality. For example, I am sure there are people out there with extraordinary skills in constructing quality typewriters, but since there is very little to no demand for typewriters, the skills will be practically worthless on the market.

Industries do not dry up because of undercutting, it's the drying up of an industry that precipitates undercutting. There are times when, due to changing circumstances, the value of any commodity or service decreases, whether due to new technology or changing tastes. It is when that commodity or service loses its value that people lower prices, or "undercut" to market themselves effectively. In time the whole sector may dry up completely, as it did for typewriters.

In what sector of the economy did a commodity or service ever disappear because of competition? There would be a price where the company or individuals providing that commodity or service simply did not make a profit, but why on earth do you expect them to set prices below the profit margin, to choose to not make a profit!?

Is it more efficient to hire more slipshod workers or fewer skilled workers? I don't think so. You do that with software, and you end up with a product promising endless patches. Do it with auditing services, and you run the risk of missing regulatory compliance. How about legal services?

It is not a categorical decision either way. There are degrees of quality and corresponding prices, as well as varying importance placed on those factors you describe. The decision where to place the trade-off s one for the employers, and should they make an error that is their's to learn from.

It is not even always the case that a lower price means lower quality, it may simply be someone with less experience wishing to prove himself to an employer, accepting a lower wage in recognition of the extra risk involved for his employer. In fact, these kind of rules tend to hurt inexperienced and poor most of all, since they are not allowed to compensate employers for extra costs with lower wages.

Besides, this in no way suggests that price floors are a smart move, it simply highlights a trade-off which employers must evaluate when making hiring decisions.

It is possible to make objective assessments. How does anyone place a value on their work? If your work is not on par with that of your peers, then charge less. If the market only bears x, then x is what you charge. But if you promise a certain level of service and fail to deliver, you'll face the anger of your customers.

You ask how does anyone place a value on their work, and I say they weigh the potential rewards for a given job against what they could have done otherwise with the same time and money. This is an entirely subjective assessment, and a lucky thing, too. Notice that you value the money an employer is willing to pay more than your work, or else you wouldn't have made the exchange, likewise the employer values your work more than the money they pay you for it.

If value is objective, then this exchange should never have taken place, since you would simply have exchanged things of equal value and wasted a whole load of time. The very fact that it is mutually beneficial means that no estimation of value is objective. For example, I scarcely value your work at all and certainly wouldn't pay for it.

As for women. No, when I go for a job, I don't intend to undercut. I've been told sometimes that companies hire women because they're cheaper, but see who's in positions of authority. This kind of nonsense matters to me, since I am a female in a field that's 80-90% men.

Do not be misled by ideologues and sloppy statistics. Indeed, once factors such as marraige and children are controlled for, the disparity between male and female wages almost disappears completely. It all depends on what way the statistics are cut, and most of the time they are cut for ideological ends.

It may be a dismissive comment, but I'm basing my observations on practical experience, not theory. In the end, what works and what I can live with are what matters.

Don't kid yourself, your last post was full of theory. There is no such thing as raw observation, nor can we even begin to understand any observation except with reference to a whole host of theories. In the above you not only theorised that undercutting killed markets (a bizarre conclusion, why does a high demand dry up a business, and why do businesses not want to make money!?), but that value can be understood objectively (something you have confused with the objective information prices carry about underlying realities), and undercutting on prices inevitably led to poor quality services (which may be true, but the important question is at what point does the compromise between price and quality become optimum. Needless to say, something for individual businesses to decide, not you).

[darlets]

Some of my mates have a few years more experience than me and hence contract out for more. So I just ask for their rate and the employer normally knows I'm asking for too much and they offer what I'm worth.

You don't ask, you don't get.

[Xander]

Undercutting applied without due care and attention is also called stupidity.

Mind you applying most things blindly is daft.

I reckon you can undercut very effectively, economies of scale allowing for one such variation of this, but I also find a backlash starting in this culture. There are people for whom "you get what you pay for" is more than a warning. It is their purchasing philosophy, often seeking the higher priced item convinced of it's superior quality. Also people are discovering that going for the cheapest option is not always the most cost efficient option. If you get too much hassle and lost time & money by buying cheap tat then you may well end up paying more than if you'd bought the premier item.

Oh and sticking to your guns on price is sometimes the best way to win the game as people assume that as your convinced of your price then you must be worth it.

Of course all this is mere politics and people should just state a price and leave it but humans cannot live so simply and as such we are always going to be plagued by one fad or another.

[ptgatsby]

There is one main reason not to undercut;

Those that charge less are seen as having an inferior service/product, regardless of real merit.

The rest just depends. If you are not getting jobs because you charge to much, you 'undercut'. But if you undercut just to push someone out, you are harming yourself and others - you could spend your time finding another job and end up ahead. In cases where competition becomes the main motivation, undercutting is harmful. Nocture argues from the completely rational actor viewpoint which is rarely reflected in day to day dealings... but is accurate.

[reason]

Originally Posted by ptgatsby

Nocture argues from the completely rational actor viewpoint which is rarely reflected in day to day dealings... but is accurate.

I make no presumption of a completely "rational" agent, or homo economicus. That's just a straw man people like to project onto opponents, somewhat like "reductionists" or "adaptionists."

[ptgatsby]

Originally Posted by nocturne

I make no presumption of a completely "rational" agent, or homo economicus. That's just a straw man people like to project onto opponents, somewhat like "reductionists" or "adaptionists."

Just to clarify, I don't agree with Rivercrow that "never" is correct, so I agree with you on that. I do agree that undercutting can be hazardous to the market segment, if it is not an adjustment in supply/demand.

For example;

In a fully rational market, the rational actor would not undercut if he could get full value for his services somewhere else. In a smaller and higher friction market, this is not the percieved/actual case. Non-rational actors do not perform an accurate risk assesment, or loss estimate, for waiting for the next job, thus over discount their price to get the job. This causes prices to be pushed down from what would be a rational level.

In a rational market, people would properly discount their time to find a new job. In a less rational market, actors have more motivation to land a job, any job, either for tangible reasons like mortgages or emotional reasons like family pressure.

In a perfect market, the servicers would know the value of their competitors and thus be able to gauge their service prices accurately (the same goes for buyers). In a less rational market, the servicers need to account for a lot of factors, including factors that are very difficult to price - both emotional (working relationship, QOL at work) and practical (ie: repeat business speculation, resume value, etc) that cause fluctuations in their competitors.

In a perfect market, the services would be seen as a commodity. In markets where each service is not easily seen as a commodity, there is an information gap and subjective opinions that change the rational pricing mechanism. This can be seen in her benchmarking of services. The buyers are not always rational and benchmarks play a role in how much one can charge for their services.

Likewise, the value of maintaining a relationship with your peers has variable value and is a component in the stickyness of (imperfect) markets.

--

As such, I think Rivercrow is right that one shouldn't undercut and undersell their own services, but make an effort to price them in line with established prices. I also think you are correct that the market mechanism of 'undercutting' can be indicative of a change in supply/demand, forcing 'undercutting' (I'd call it pricing to get a job!). What I argue is that 1) Rivercrow is incorrect in saying that it is never correct to lower prices since clearly it is still a competitive market 2) That undercutting is always a rush to the exits and that it carries no cost to the industry as a whole (compared to other industries that the money could be spent).

If you are in a segment of the market, you have a vested interest in keeping a certain image of the market. Undercutting can damage that image and lower prices, merely on perception (demand does go down, you are correct, but it isn't a typewriter... It's more like german sheppards in WWII.)