Competitive pricing strategy is one of the most thrilling and terrifying aspects of pricing – thrilling because it is a high-stakes game, and terrifying because you can get locked into a price war and end up swimming in a sea of red ink.
I’ve seen many unnecessary price wars over the years, usually the result of “an-eye-for-an-eye” pricing. In other words, if they hurt us, we’ll hurt them right back. That is rarely the recommended response. Instead of retaliating with aggressive price cuts, it is better to devise some alternative courses of action.
To have an effective competitive pricing strategy, you must adopt a mindset of diplomacy. Why? Pricing is unlike any other area of your business. Everything we do in business is geared toward beating the competition, whether in market share, profits, innovation, marketing or manufacturing. Let’s face it, business is all about winning -but not when it comes to pricing. Pricing is different because in the long run, it’s win-win, not win-lose like most other aspects of business. Lowering prices to gain share is typically not a sustainable strategy. Competitors can usually match, and then you will all end up losing money.
Our natural reaction to a competitor’s price moves is dismissive. A much more constructive approach, however, is to assume your competitor is intelligent and is pricing this way for a good reason. Your job is to figure out that reason and respond effectively. One senior executive, for example, recently realized that a competitor he had been denigrating for years for its low pricing was actually making huge profits by loss-leading with price in the first two years and then capturing profits on the following years (the razor and blade pricing strategy). Now his company is doing the same thing and making much higher profit than it did before.
Here are some points to consider when planning your competitive pricing strategy:
1. What are your market-share goals and those of your competitors? A major cause of price wars is that the goals of all the players significantly exceed 100% of the market. Consequently, everyone is fighting for share, and price becomes the lever. By setting appropriate market-share goals and focusing on creating new markets (think Apple), you can stay out of price wars.
2. Is there overcapacity in the industry? That is the main driver for price wars, because it creates a huge incentive to sell available capacity cheaply. But if you and your competitors resort to “fire sales,” then the customers who are paying full price will want those discounts too. It’s much better to adjust capacity downward. For example, during the financial crisis, Toyota quickly reduced capacity to prevent an imbalance between supply and demand of its vehicles. As a result, it protected margins while GM and Chrysler filed for bankruptcy.
3. Are you saying “no” to customers? If not, it means you are trying to be all things to all people, and you lack a pricing strategy. Focus on your natural customer segments, and on winning in those segments profitably.
4. How will your actions be interpreted? Many companies price aggressively, thinking, “just this once, we’ll take some business from the competition.” But your competitors will likely not sit by idly and let you take their market share. The next thing you know, they respond and you are on the downward spiral of a price war. Good competitive pricers think about the impact of their pricing actions several moves out.
5. Do your competitors have a cost advantage? If so, you may have to cede some ground to them. Many retailers made the mistake of trying to take on Wal-Mart head on and matched its pricing when it came to Canada. This was a foolish tactic because Wal-Mart has a lower cost of doing business and a strategy of having the lowest price in the market. When Loblaws and other retailers tried to emulate Wal-Mart, they failed and had to change their pricing strategies after wasting a lot of time and money playing a game they could not win.
Competitive pricing is a high-stakes game, and mastering it is an essential skill for senior executives. The key is to keep a cool head and not panic when the pressure is intense. Good competitive pricers will consider all the options and be able to analyze their competitors’ pricing strategies.
Remember, generals fight wars, but diplomats fight to prevent wars. So be a pricing diplomat, not a general.
Read more at the Financial Post.
