Why Lower Prices Are Bad

Hi!

I'm not referring to Wal-Mart here (though I could, but it'd be a different topic); I'm referring to deflation. Most people look at it from only their own perspective: Lower prices means I can buy more stuff!! This, however, assumes that you'll have the same amount of money. You might, at first, but it won't be long before you'll have less. Here's why, but we'll have to start thinking about it from the perspective of a venture capitalist.

Let's say you're being pitched an idea for a product that'll sell for $10. It's a really cool new product that you're sure everyone will want. At a $10 ASP (average selling price), you can expect to get your money back, and more, in just a couple of years. The problem is that after a period of deflation, the product can only sell for $5. At a lower ASP, you may NEVER get your money back, much less make any kind of return. What do you do? Well, you certainly wouldn't invest in any new products...

This is what would happen inside companies, too. They'd have a bunch of cash, but it'd be more valuable in the future if it just sat there rather than be invested in creating new products. This means that the company really can't grow. If the company (your company) can't grow, then it will probably start shrinking. Maybe you keep your job, or maybe you just get a pay cut. Now, things are cheaper, but your salary is smaller so your real purchasing power is what it was before, maybe less. It's a downward spiral.

The lesson here is that low prices that get that way due to improved efficiency are good; low prices that get that way due to a depressed economy are bad. A little inflation is a good thing as it encourages investment and development. Now you know why the government isn't trying to drive prices down...

Thanks,
Matt