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Pricing Myths

by Donald Potter

There is a price war going on in the retail liquor department. This is good news for those of us who enjoy a drink but bad news for the liquor companies.

It seems that consumers have been switching their purchases to less expensive brands of liquor during the recession. They are not drinking less, though. The volume of spirits sold in 2009 was up by 1.4%, but the revenue remained flat due to price discounting and consumers shifting to cheaper brands.

Diageo, the world’s largest liquor producer, is part of the industry’s problem. This company has been aggressive in reducing its prices with the two-fold purpose of holding on to their current customers and gaining share against other liquor producers. The falling prices are most obvious with vodka, tequila and gin. Some competitors of Diageo are refusing to go along with the price discount. For example, Patron, the maker of Patron tequila, has resisted the price cutting. The CEO of Diageo believes that his discounting has helped the company gain market share and retain consumers. Still, his revenues are off compared to the previous year.

The equity analysts believe that price discounting will hurt Diageo’s brand equity. I disagree.

The history of many markets is replete with examples of branded goods who have had to discount during difficult times. Remember Marlboro Tuesday? How about the price wars in the 80s and 90s in beer, disposable diapers, fast food, tires, farm machinery, construction equipment, appliances and personal computers, to name just a few? Companies must respond to shifting consumer preferences and most price discounting.

An industry in overcapacity is certain to experience price discounting. It is true that this causes customers to become more price-sensitive, but that price sensitivity lasts only as long as industry competitors will discount against one another. Once the period of discounting has passed, companies regain pricing power and branded equity is as strong as it ever was. For proof, consider the brand leaders in the industries cited in the previous paragraph.

Part of a company’s brand equity with consumers is the fact that the company is viewed as pricing “reasonably” with competitors. If a company will not price with rough equivalence to its competition, it also destroys its brand equity. Consider General Motors in the 80s, IBM in the personal computer market and Xerox in copiers. You don’t want a reputation as someone who prices high just because you believe that your brand is better than everyone else’s. That way leads to big troubles.