SELF TEST #21: Price Change Opportunities
Why would a company reduce its prices?
There are two primary motivations for a company to reduce price:
First, to gain share with an attractive customer; and second, to maintain sales to existing customers when the industry's prices are falling.
Where might a company find opportunities to reduce prices to gain additional share?
The opportunities depend on the reaction of competition. More specifically, we must understand the competition's Knowledge of our move, Capacity to respond to it, and Will to risk its profits to respond to it. The first common opportunity is a customer who does not use a Last Look. Here the competitor has no knowledge of our low-price offer. A second opportunity occurs when the leading competitors in the industry are constrained because they are sold out. They no longer have the capacity to respond to lower prices that we might offer customers.
There are four opportunities to use price to gain share when the competition does not have the Will to prevent us. The first is an industry-wide move, where all competitors are reducing their prices. The second is a Leader's Trap, where a competitor is setting a Price Umbrella over us that enables us to use a slightly lower price to gain some of his attractive customer volume. Next is a new Price Point. This new Price Point introduces a Price Leader product into the marketplace that the competitor is reluctant to offer. Finally, a few, very strong, industry leaders may choose to price low in order to discourage competition from entering the market or expanding in it against them.
Why would a strong Industry Leader keep its prices low?
A strong Industry Leader is able to keep its prices low and still make good returns. It does this because it discourages other competitors from competing against it. The strong industry leader gains high market share and enjoys significant economies of scale because of their low prices. These economies of scale enable them to make good returns despite the fact that their prices are low enough to discourage competition.
What are the patterns of opportunities to increase price?
The Company is able to increase price where it is able to exploit competition's Knowledge, Capacity and Will to respond. There are seven of these typical opportunities. The first three opportunities exploit the competitor's knowledge, or lack of knowledge, of Company initiatives. In the first opportunity, the Company seeks a better cost of service in the customer relationship. The competitor rarely knows of this move. The second opportunity is to slow the pace of price declines, especially with Small and Medium customers. And the third opportunity is to raise prices on the ancillary benefits. Competitors are unlikely to know much about any of these three opportunities.
In some cases, the competition may not have the capacity to respond. Then the Company may raise prices to take advantage of this constraint on competitive capacity.
Finally, the competition may have the Will to follow the Company in its price increase, or at least not oppose it. There are three more patterns associated with competitive Will. In the fifth pattern of price increase opportunities, the Company initiates, or follows, an industry price move upwards. In the sixth, the Company exploits a unique position that it has compared to other competitors in the marketplace. It simply raises its prices to obtain a reward for this unique position. The seventh and last pattern of price increase opportunities occurs when the Company introduces a high-end product to increase the margins on customer relationships.
What happens when one of the industry's Very Large customers obtains a new low price in the market?
Generally, other customers of all sizes learn about this new lower price and demand a similar percentage price reduction from their suppliers.
How fast do new low prices spread in a marketplace?
The Answer to this question depends on the characteristics of the industry. However, in industries we have monitored, a new low price spreads in a matter of days to other Very Large customers, within two weeks to the Large customers, and over a longer period of time to the Medium and Small customers.
Return to Self Test #21