Countering Falling Prices with StrategyStreet

Our Experience in Pricing: Articles on Pricing

The Price Segment

by Donald Potter

Customers buy according to a hierarchy of needs. They choose suppliers after considering their needs for function, reliability, convenience, and price, in that order. Since each customer buys from the one supplier who is unique in meeting one of these needs, customer volume falls into one of these four segments.

The price segment is not nearly as attractive as many assume.

Price Segment is Small

"Price affects many decisions but little volume."

Price is a factor in many customer decisions, but it moves little volume. This seeming contradiction is explained by the locus of price sensitivity in a marketplace. Medium-sized customers, and some small customers, are the most price sensitive. There are a lot of those people, but they don't buy much.

Large customers seldom turn out to be price sensitive. They know they get the best prices. They assume that they will benefit from price drops — or else.

Small customers could be price-sensitive, but less than half of them seem to be so. The price-sensitive half are struggling marginal operators on their way out of business. The other half offer superior services to niches. These niche players know thy have little leverage with suppliers. They don't even try to compete on price.

Medium customers are the most price-sensitive. They are often trying to compete with larger firms for the same clientele, and are attempting to offer both good service and low prices. Their volume is important to suppliers, so some of them succeed in wringing price concessions.

In all, less than half the customers and roughly 15% of the volume in a hostile market will actually be decided on price.

Consider today's airline industry. Many of the passengers may be flying on discounted tickets. But these same tickets are offered by almost every airline. Very few passengers, indeed, fly on tickets that cost less than any other airline would offer.

Customers in the Segment are Weak

The most price-sensitive customers in hostile markets tend to be weak customers. Their own market strategies are flawed. Price-sensitive customers try to do more for less with neither the scale to carry out the "less" nor the margins to offer the "more". No matter how hard they bargain, few, if any, will achieve the maximum price concessions that would allow price competition with larger firms. Nor do they offer the service levels of the smaller, higher-priced firms. Their margins won't allow it. They are stuck between the two basic market approaches. Doing neither well, they often lose share in their own markets.

The plight of many mid-sized retailers in the personal computer market illustrates the problem. These companies are stuck between the larger mass merchandisers with their broad selection and low prices, and the value added resellers with their more costly, customized, product offerings. These mid-sized retail customers of computer manufacturers are losing market share to their competition at both ends of the price spectrum.

Faced with this dilemma, price-sensitive customers send their suppliers inconsistent signals. For one period, they want low price. For the next, they need better service. Suppliers struggle to remain responsive to their changing demands.

Caution: Risk of Low Returns

"Price oriented suppliers are weak."

Companies that try to serve this demanding price segment by emphasizing low price as their major source of differentiation from other competitors usually weaken themselves in the process. These companies are forced to discount their offerings from 2% to 5% off the market price in order to gain volume or at least hold share.

The result is almost always low returns. In most markets, companies that try to compete on price must give up more in discounts than they save by offering a lower-performance package.

This is the world of Renault in the domestic automobile market, Savin in plain paper copiers, Data General in mini-computers and of many regional brewers. Mars looks about as inviting.

Any company contemplating the pursuit of the price segment in a hostile market should examine the segment carefully before undertaking the chase with vigor.

Closing Thought

The weakness of price-sensitive customers and price-oriented suppliers is related. A supplier has difficulty establishing a relationship with a price buyer. This buyer must be resold continuously and, thus, requires higher sales cost than does the less price-sensitive customer.

(Note: This Perspective was written in the context of the economy in 1993. While some of the companies may have changed their policies or indeed no longer exist, the patterns they exhibit still hold today.)