Every partnership has its ups and downs, and the one I have with Bob Feinstein hit rough water last spring. Back in 2000, he and his son Trace joined me in starting a document-destruction business. About a year ago, the demand for that type of service began to explode, thanks mainly to the implementation of several new privacy laws. As a result, hundreds of small operators poured into our market, undercutting our prices, going after our customers, and generally doing all they could to tear down what we'd spent five years building up. I was absolutely thrilled. Bob thought I'd lost my mind.

It's natural to feel a twinge of panic when faced with a swarm of new businesses willing to do what you do for a lot less money. But I didn't think most of these companies were actually competitors of ours, and I believed their presence in the market signaled a critical transition in the industry that would greatly benefit us in the long run.

The truth is, our biggest problem from the beginning had been a shortage of competition. I'd even gone so far as to help other people get started in the business, knowing that they might someday compete against us for new accounts. (See "A Few Good Competitors," August 2002.) Why did I want more competitors? Because they'd help us educate the market about the need for document-destruction services. In a young industry like ours, you have to spend an inordinate amount of time and money just explaining what you do and why prospective customers should pay you to do it. The more competitors you have, the easier that task becomes. As the industry matures, the market expands, and customers focus on the type of service they want rather than whether they need the service at all. And then you can spend more time explaining why they should buy your service rather than somebody else's. That's a lot less time-consuming--and leads to a lot more sales--than having to explain the whole concept.

But there's a scary phase you have to go through before you get there, and we're in the middle of it right now. I call it "free fall." It begins when there's a dramatic increase in the general awareness of the opportunity to make money in a given market. In our case, the explosion was triggered by new laws and regulations making businesses responsible for protecting their customers' confidential information by, among other things, disposing of it in a secure manner. Suddenly the floodgates opened. In rushed all kinds of service providers, a lot of them operating with little or no overhead. Working out of their homes, they would put a shredder on a truck and drive from location to location, destroying documents as they went. They could charge a lot less, which meant prices began to fall and margins to shrink.

That can be unsettling, especially if you think the trend is going to continue. As the competition heats up, you find yourself having to work harder to get and keep customers. If the price of a product or service drops by a third, you have to sell 50% more just to stay at the same level of sales. With lower gross margins, you'll have to increase your sales even more to earn the same profit as before.

Even though the market is expanding, and there are more customers for everyone to go after, you tend to focus instead on the increased competition. You notice that accounts you could have landed easily in the past are now subject to intense bidding, and you win a smaller percentage of them. You may also lose some customers who are willing to accept a lower level of service to save money. Meanwhile, every day you hear of a new player entering the market and some new, ridiculously low price being offered for more or less the same service you provide. As the months go by, the situation continues to deteriorate. If you don't keep the big picture in mind, it can feel as if your business is crumbling around you. Under the circumstances, it's not surprising that a lot of people panic. They try to compete with everyone instead of focusing on their niche. They also start jumping to conclusions about what customers must be thinking, which is always a bad idea.

Recently, for example, we heard that one of our largest customers, a hospital, had assigned its toughest compliance officer to review what it was paying for various services, including document destruction. We knew that other companies were after the business, and that they would offer a lower price than we were charging. We realized we'd have to move quickly if we wanted to hold on to the account.

We decided to ask the customer for a meeting and send in a team composed of our ace saleswoman, Patty Kanner Post; our sales manager, Brad Clinton; and Trace. I suggested that they present a plan to help the hospital save money. We'd been monitoring its service, and we knew it could have us do fewer pickups without any loss of security. We'd just have to educate the hospital's people.

Bob was skeptical. "That's not enough," he said. "We're losing that account."

"How do you know that?" I said. "You have no idea what they're thinking."

"Yes, I do," he said. "That's why they brought in the compliance officer. I think we should cut our price in half."

Trace agreed. "We have no choice," he said.

But offering a huge price cut out of the blue was like saying we'd been ripping the customer off all this time. The customer would never trust us again. What's more, the loss of margin would make it almost impossible for us to continue providing a superior level of service and would thereby undermine our position in the market. Our goal was to be a high-quality, high-service, high-margin provider competing against companies with a similar philosophy. If we let ourselves get into a price war with the small, low-margin operators, we would wind up abandoning the path that would lead to our success in the long run.

Besides, it was by no means clear that the customer wanted us to slash prices. "We need to let the compliance officer tell us what he's looking for," I said. "We shouldn't even discuss pricing unless he talks about it. Just say, 'One thing we do for our customers is to advise them how to reduce their costs. We can do that for you as well. The problem is that your employees haven't been educated about what needs to be shredded and what doesn't, and so they're giving us too much paper, and we're doing more pickups than necessary. We can teach your people how to use us better and save money." The key, I said, was to take control of the meeting from the start, present our plan for saving money, and then listen closely to what the customer's people had to say.

That's exactly what Brad, Patty, and Trace did. When they arrived, there were six people waiting for them. One of them said, "I think I called this meeting."

"No, we called the meeting," Brad said, "and we wanted it for a specific reason." He and the others proceeded to explain why the hospital's costs were higher than necessary and how they could be reduced.

"I have to respect somebody who comes in here to show us how we can save money," said the compliance officer. "My questioin is, how much?"

The compliance officer was sitting in the back, listening. "I have to respect somebody who comes in here to show us how we can save money," he said, when he finally spoke up. "My question is, how much? Do you think we can save 20% or 25% on the service?"

"I'm sure we can do that as long as we work together," Brad said. "We'll start on it right away."

So we didn't have to lower our prices after all, at least not in that instance, but Bob still wasn't convinced. Shortly thereafter, we learned that Iron Mountain's document-destruction division was going after another big customer of ours, offering to do the work for half of what it was paying us. "See, I told you," Bob said. "Half the price!"

"Have you seen the proposal?" I asked. "I don't think you're comparing apples to apples here. Iron Mountain can't do what we do for half as much."

Sure enough, it turned out that the proposal called for 24 pickups a year, as opposed to the 52 we were doing. We let the customer know that we could charge half as much, too, if it could live with such a drastic cutback in service. The customer decided to stick with what it had.

Understand, I'm not saying we've been able to hold the line on prices across the board. Our average price, like everyone else's, has declined, and we've had to make up the difference by learning how to operate more efficiently. For example, we used to send two guys on a truck to empty a customer's bins and bring the paper back to our facility. Now a driver drops the guys off and goes on to do other pickups. As a result, we get more productivity out of our people and our trucks.

Those are the types of things you have to do during a free-fall period if you want to maintain your market position and prepare for the next phase. That phase is surely coming. I figure we're about halfway there. Pretty soon, prices will stabilize, and we'll see a clear differentiation in the market. Some customers will want bargain-basement prices, while others will be happy to pay 5% or 10% more for a higher level of service. Those are the customers we'll be going after, and our only real competitors will be those who take the same approach. From that point on, we'll seldom run into the low-margin guys anymore.

Maybe then Bob will stop thinking I'm crazy.

Norm Brodsky is a veteran entrepreneur whose six businesses include a three-time Inc. 500 company. His co-author is editor-at-large Bo Burlingham.