Part 2: Company Price Environment
Price Sensitivity Among Customers
Capsule: There is opportunity to use price to improve profits as long as customers do not become price sensitive. The industry’s competitors teach a market to become price sensitive. As customers become price sensitive, they begin to use the “Last Look” tactic in order to extract even lower prices from their best suppliers. Ironically, “Last Look” drastically reduces price-based competition.
For helpful context on this step:
- Video #72: Overview of Pricing Part 1: How to Look
- Video #73: Overview of Pricing Part 2: What to Expect
- Video #26: Example of the Customer Buying Hierarchy at Work
- Video #42: Leader’s Trap
- Video #40: Price Shaver
- “Entering A Different Dimension”
- “The New Pricing Structure”
- “Turmoil Below: Confronting Low-End Competition”
- “Why Price Cuts Don’t Build Share”
- “The Leader’s Trap”
Symptoms and Implications:
- The industry is seeing its first price wars
- Customers are more price sensitive
- Most competitors are offering low prices after a period where leaders held prices high
- Some competitors seek price increases more aggressively than others
Price sensitivity among customers implies that the industry’s larger customers have learned to use “Last Look” with their suppliers. Before Last Look, Price Gaps on similar products from one competitor to another are large. Last Look develops slowly as some competitors exploit these large Price Gaps by discounting prices or by introducing Price Leader products. The leading industry competitors, who dominate the relationships with Very Large and Large customers, may fall into a Leader’s Trap and allow low-priced competitors to take share in the market. These discounters prosper, improve their products and begin appealing to the industry’s larger customers. Last Look ensues. The widespread use of Last Look by customers on similar products results in list prices among competitors that are virtually identical. Price differences do continue to exist but now they are different from one customer to another rather than from one competitor to another. The implication of these developments is that the Company must employ a surgical approach to pricing, mixing both defensive and offensive price tactics to use the price tool effectively. To succeed, the Company needs more detailed information on the way Price affects the market.
Prices Before Last Look
The competitors in an industry enjoy a relatively comfortable pricing environment as long as customers do not become price sensitive. Price sensitivity, the customers’ willingness to change suppliers for a low price, takes time to develop in a market. In the early stages of an industry’s evolution, or in the fortunate case where an industry has little price competition, competitors charge notably different prices for apparently similar products. The market sees substantial Price Gaps from one competitor to another. Prices from one competitor to another for the similar products may vary by thirty percent or more. For example, IBM and Compaq personal computers carried prices nearly fifty percent higher than their low-priced, but similarly capable, “clone” competitors in the early years of PC competition.
These Price Gaps result from the different product pricing policies the companies follow. The more expensive product receives a premium price because the producers of the less expensive product must discount their product prices to sell against the more expensive product. The producer of the more expensive product allows this competitive discounting by failing to match the lower price. This higher-priced producer may allow the discounting to protect his profits or because he determines that the lower priced product is a lower Price Point product than his own.
If the higher priced producer were to reduce his price to the level of the lower priced product, it is likely that the lower priced producer would respond with yet lower prices. In reality, a price premium is always the result of a weaker competitor having to discount its product in order to sell, rather than the result of the stronger competitor succeeding in demanding a price premium.
Leading companies sometimes proudly proclaim their products’ premium prices in the market. This claim focuses the attention of a prospective customer on the price differences among products, where the leader is, in fact, weak rather than on the performance differences, where the leader is usually quite strong.
This large variation in pricing sets the stage for Volatility on price. Where price differences across competitors are large, the market develops substantial Positive Volatility on price. Positive Volatility on price occurs when some competitors gain volume by using a low price as a competitive weapon. This volatility is substantial because the Very Large and Large customers begin to migrate toward low-priced competition as those competitors improve their product quality and reputation.
Price Sensitivity Among Customers Questions
- What are the average prices each competitor charges for the Standard Leader product? (Analysis 47 and Analysis 48)
- What accounts for the Price Gaps from the highest to the lowest average prices?
The Development of Last Look
In the early stages of developing price sensitivity, smaller customers may be price sensitive, but the industry’s larger customers are not. At this point, there are relatively few competitors whose performance package meets all the needs of the Very Large and Large customers. The average larger customer prefers an amicable relationship with his supplier and is reluctant to “shop” that supplier’s price to other competitors in the market. Over time, however, more competitors, including discounters, refine their capabilities to serve the larger customer segments.
The word “discounters”, in some ways, is a misnomer. The low-priced competitor may be a Predator discounter, one who offers a product with Functions similar to the Standard Leader product, but less Reliability and Convenience, at a low price. These are Price Shavers. There are, however, other companies who follow a different path to low prices. These are Strippers. They reduce the benefits for both the user and the buyer of the Standard Leader product, saving costs. They use this lower cost to offer the customer low prices. Predators (including Price Shavers) and Strippers are the two primary types of Price Leaders. Both may fall under the rubric “discounter.”
If unopposed by the industry’s leaders, discounters begin succeeding. They operate at high utilization rates and garner attractive profits. They use these high profits to improve their performance. The discounting competitors grow faster than the market. Their investments in their products bring their performance closer to that of the leading competitors, who will not discount. The discounter product becomes more reputable and acceptable for the larger industry customers. This greater acceptance encourages even more price-based competition.
By now, the industry’s leading competitors, who refuse to counter the discounters in either price or Price Point, are in a Leader’s Trap. They hold a Price Umbrella over their low-priced competitors in the beliefs that their higher price will protect their margins and that their customers will remain loyal to them.
Neither assumption proves out. The larger customers begin experimenting with low-priced products. Industry prices begin to fall as these low-priced products, and their producers, succeed in the market. Companies in the Leader’s Trap lose both price-based margin and sales volume.
Initially, the low-priced suppliers gain Positive Volatility volume from the companies in the Leader’s Trap by winning customer sales from those companies. Over time, however, this Positive Volatility due to price is the result of failure by the companies in the Leader’s Trap. This occurs as most competitors learn that they must counter a low-priced competitor or risk losing sales volume. The necessity of meeting the low price generates the need to know of the low price.
Once price-based competition has established a foothold in the larger customer segments, suppliers incumbent in relationships with these customers learn to ask their good customers for the privilege of “Last Look.” “Last Look” begins with the industry’s Very Large and Large customers. “Last Look” means that the customer would offer the incumbent supplier a chance to match any low price offer the customer would receive from another supplier.
This “Last Look” spreads throughout the market. With time, the majority of customers learn that they can get lower prices and still maintain their good customer relationships by using this “Last Look” approach. In turn, competitors learn to match lower prices from Peer suppliers, or risk the immediate loss of some or all of the sales made to the customer.
Price Sensitivity Among Customers Questions
Market Segments Where Share Moves on Low Price
- What percentage of the total market’s sales volume is purchased by Very Large and Large customers who offer “Last Look” to their incumbent suppliers?
- How much Negative Volatility does the industry have due to pricing?
- What is the industry’s Positive Volatility on price?
- How has the balance between Negative and Positive Volatility on price changed in the last several years?
- In what Size/Role market segments is low price moving market share? (Analysis 49)
- Is any company in a Leader’s Trap today?
- Who are the industry’s Price Shavers?
- Are there any Price Leaders in the market?
- Are there any 100% customers in the company’s portfolio, if so, are they more or less profitable than expected?
Effects of Last Look
“Last Look” drastically reduces Price Gaps and price-based competition. It may lead to a Hostile market.
“Last Look” drastically reduces, but does not eliminate, price-based competition. Some competitors might remain committed to the idea of receiving a premium for their products and services. Some customers remain dissatisfied with their prices. Price Shavers continue to exist in most markets. These competitors usually offer discounts averaging 2 to 5 percent against the industry Standard Leaders’ products in order to attract and hold their limited market share. Once “Last Look” is imbedded in a market, though, most of the industry’s Volatility due to price is Negative Volatility. And there will be little of that once Leader’s Trap ends.
- Audio Tip #125: Should You Tell the Customer You Expect a Price Premium?
- Audio Tip #112: The Effect of Last Look
Positive Price Volatility would be less than Negative Price Volatility in an average marketplace. Positive Volatility on price is often lower because at least some competitors would be willing to match any lower competitive price in order to retain the customer volume and relationship.
Negative Volatility due to price occurs to an incumbent supplier when a customer moves some or all of his purchases from that supplier to another because the incumbent supplier insists on a higher price than does the supplier who gains the volume. This occurrence may happen because the incumbent refused to meet a lower price in a “Last Look” opportunity, a “failure”, or because the gaining competitor “won” the volume by offering a low price that the customer accepted without using “Last Look” with its current suppliers.
Positive price volatility becomes much more difficult to create with the widespread use of “Last Look.” An instance of Positive Volatility on price requires either that the customer not offer his incumbent supplier a “Last Look” on the low price offer or that the incumbent supplier refuse to meet that price. The Company should be particularly sensitive to competitive Positive Volatility on price if the company is one of the market’s high priced competitors. This kind of volatility, if left unadressed, leads to very strong low-priced competition.
Once “Last Look” is fully established in a marketplace, the company must be careful when and how it uses the pricing tool. By that time, the key customer size/role market segments are no longer moving on the basis of a low price. Competitors have learned, usually the hard way, that refusing to match lower prices offered by a peer will result in lost sales. The effective use of the low price tool migrates to the outlying smaller relationships, those with Small and Medium customers or Tertiary roles with Very Large and Large customers.
Once customers become price sensitive the company feels constant pressure on pricing. This downward pressure starts in Deteriorating markets and becomes widespread in Hostile markets. Some customers constantly demand lower prices and threaten to move their business if their supplier refuses the demand.
“Last Look” may progress to the point where the industry becomes Hostile. A Hostile market sees pricing opportunities of a new kind. A Non-Hostile market sees Price Gaps because competitors price their products with similar benefits differently from one another. The opportunity here is to exploit the different product pricing policies of competitors.
A Hostile market, in contrast, sees much lower product Price Gaps from one competitor to another. In fact, competitor list prices may all be identical. Instead, prices vary from one customer to another. Differences in the sizes of the purchasing power of two customers may account for some of the price differences from one customer to the next. But this explains relatively little. In a Hostile market, several customers may all be of a similar size but each may pay a different price for the product. And some Small customers will pay much lower prices than some Large customers.
- Audio Tip #158: How Much of a Hostile Market is Volatile on Price?
- Audio Tip #110: Customer Size and Negotiating Ability
Prices vary primarily by customer rather than by competitor in Hostile markets because of customer, rather than competitor, policies. “Last Look” takes away most of the secrecy in competitor pricing and a good deal of the reward for discounting.
Price differences in Hostile markets are the result of customer practices and policies. Those customers who aggressively seek lower prices generally get them. Those who do not demand as aggressively do not get the lowest prices. They may, however, receive better service because they are more valuable to the supplier.
In a Hostile market, virtually every customer pays a unique price. This price reflects the customer’s ability and will to negotiate. Managing pricing, and the profits price differences can create, becomes a matter of careful customer selection and service, providing customers continue to pay the same prices relative to other customers over time, and most do so.
If the market becomes Hostile, the Price Gaps among competitors become much lower than they are in Deteriorating and Stable markets. Price gaps fall from 25 – 50% in Deteriorating and Stable markets to an average of less than 5% in Hostility. The Primary and Secondary supplier usually receive the same price and Price Leverage roles receive a few percent less. (See more about competitive dynamics in Competition and Their Knowledge, Capacity and Will.) But, there are substantial differences in prices that customers, even with the same level of industry purchases, pay suppliers. Then, managing these price differences across customers becomes a profit opportunity.
- Audio Tip #127: Price Gaps in Hostile and Non-Hostile Industries
- Audio Tip #108: Price Leverage and Pricing
- Audio Tip #109: Price Leverage Compared to Price Information
More Price Sensitivity Among Customers Questions
- What returns do Price Leverage roles offer today? (Analysis 50)
- Who are the Company’s “Peer” competitors?
- What price does each customer pay for the Standard Leader product? (Analysis 67)
- What explains Small and Medium customers who pay low prices?
- What explains Very Large and Large customers who pay high prices?
Implications of Last Look For Company Pricing
Once “Last Look” is well established, the days of product based pricing have passed. The Company is likely to need to negotiate prices, individually, with each important customer. The Company must gather new facts to get the most out of its pricing policy.
With “Last Look”, many customers take effective control of the prices they pay. The vast majority of individual, rather than industry-wide price declines are the result of customer, rather than competitor, initiatives. Customers have incentives to use every trick to coerce a price reduction. They will claim a lower competitive offer. Many will bluff their way to a discount.
On the other hand, competitors have little incentive to offer these discounts. If these discounts fail to generate immediate new business or if they should spread to other customers, the discounts result in poorer financial returns. But “Last Look” takes away much of the potential for a discount to create Positive Volatility (i.e., a Get In or an Increase Use opportunity). And industry word-of-mouth inexorably spreads the news of any legitimate price discount. Surprisingly, it also broadcasts the news of the successful bluff by a significant customer resulting in a new, lower price. New low prices spread to other customers.
With widespread “Last Look”, and especially in Hostile markets, a pricing policy makes money with nickels and dimes. The opportunities to reduce price to gain share have short lives. The extra margin available through higher prices depends on superb knowledge of the customer’s attitudes and of competitive pricing tactics.
Once the Very Large and Large customers in the market have become price sensitive, price pressure is likely to be relentless, even while opportunities to gain share on price are few. The Company must begin using more Defensive pricing tactics to protect its current Core customer volume. It may use Offensive tactics only surgically. Defensive tactics are really the order of the day. These tactics require better information about where and how low price moves share.
The Company will be most effective with its surgical pricing tactics if it can predict how customers and competitors will react. For the most part, both customers and competitors are predictable. Customers are fairly stable in the relative prices they pay. We have examined relative pricing by customer in several markets. Roughly speaking, we have found that two thirds customers of the Hostile markets maintain their same relative prices over a period of several years. For example, two thirds of those customers who pay 2-3% higher prices than average for their purchase size in one year would be paying the same relative prices, 2-3% higher than average, three years later.
Competitors are even more predictable in their pricing decisions. Most show clear tendencies. Some competitors prove sticky on all price declines and aggressively seek price increases. The industry’s leaders often follow this pattern. Others will offer low prices aggressively and resist price increases. This pattern is characteristic of Price Shavers. Both of these types of pricing tactics are internally consistent. They follow clear pricing guidelines. A few competitors seem to have no coherent pricing guidelines. They are sometimes high and sometimes low. Competing against these competitors is a crap shoot.
- Audio Tip #111: Relative Pricing is Predictable
- Audio Tip #138: Predicting Competitor’s Relative Pricing
If the company is able to predict the relative pricing behavior of both customers and competitors in a price-competitive market, it increases its chances of gathering the nickels and dimes that price opportunities offer.
The power of the pricing tool declines markedly as a market moves from Non-Hostile to Hostile conditions: A Non-Hostile market may see total volatility of 10% a year with 35% of that volatility due to Price. This means that a low price can move 3.5 share points a year in a Non-Hostile market. In a Hostile market, volatility may be only 4% a year, or lower. Price accounts for less than 15% of volatility in a Hostile market. So a low price moves less than 0.6 share points a year in a Hostile market. Comparisons of an average Non-Hostile and an average Hostile market suggests that price-based volatility falls by more than 80%, from 3.5 share points a year to 0.6 share points a year.
More Price Sensitivity Among Customers Questions
Time to Lateralize Price Discount
Relative Price by Customer
Loss on Price Index
- How long does a new low price take to spread to each customer size segment? (Analysis 52)
- How stable are relative prices paid by customers over time? (Analysis 68)
- When relative prices of customers change, what explains the change? (e.g. explain changes such as those in customers Violet, Black and White in Analysis 68)
- What pricing guidelines is each competitor using in the market? (Analysis 51)
The tougher the market, the more important it is to know when to say “no” to a discount demand without falling into a Leader’s Trap. Success here requires a good analysis of competitor motivations, clear pricing objectives, a deep understanding of the pricing opportunities the market offers, the use of multiple components of price and a highly informed pricing process. We cover these topics in the next several sections.
- Self Test #20A: Evaluating Price Sensitivity Among Customers
- Worksheet #20A: Evaluating Price Sensitivity Among Customers