WHO HAS PRICING POWER?


by Donald V. Potter

One of the first clear signs that a market has become hostile – or that hostility has ended – is a change in who sets prices. Pricing power shifts markedly as a market moves into and through hostility.

When Leaders Lead

"In early hostility, less dominant suppliers set prices."

In a non-hostile market, the "market leader" (that is, the dominant company with the largest share, widely known brand name or franchise, and established channels of distribution) sets its price. That price is typically the full cost plus the desired margin. And, since costs in non-hostile markets typically rise over time, market leaders inch their prices upward.

Smaller, less dominant competitors set their prices, usually under the price leadership of the market leader. Once the market price structure is set, smaller competitors rarely discount, because they do not want to prompt retaliation from the market leader, and because their share and margin seem sufficient, so there is little enthusiasm for "leaving money on the table."

Customers generally pay the prices their suppliers set. They seldom protest because price is rarely the crucial determinant in a buying decision: product/service features and the convenience and reliability of the supplier are more important-a fact that suppliers will point out to those customers who do ask for better prices. With few, if any, other attractive suppliers actively vying for their business, customers know they have limited leverage with current suppliers. In short, they can "take it or leave it."

"About Face"

Imagine a leader confidently marching up the road, then glancing over his shoulder to see that his followers have pivoted and are marching in the opposite direction. Something similar happens to leaders when hostility begins. The market leader may announce a routine price increase, only to find that at least some less dominant competitors are refusing to go along, or are even discounting their prices. These followers believe that the time is right to gain share by cutting price. They usurp pricing power.

Less dominant suppliers now begin
offering customers lower prices-a gift that is hard to refuse if the supplier can also offer acceptable product features, convenience, and reliability. As the market moves into hostility, share begins to shift. In the fight to stop share erosion, more and more suppliers drop their prices. Hostility intensifies.

Market Mutiny

"In later hostility, customers lead."

In a fully mature hostile market, pricing power slips away from suppliers and into the hands of customers. Aware of the intense competition for their business, they can now insist on lower prices. If a supplier hesitates, customers can make good on their threats to shift their volume.

Prices fall until, on the largest pieces of business, they barely exceed variable costs.

By now, the market leader has usually been wounded, especially if it has delayed dropping its prices and has lost significant share. The unpleasant truth is that once hostility begins, the market leader has no pricing power
unless it is willing to lead prices downward. Furthermore, the dominant company cannot regain pricing control until market hostility has played itself out-as American Airlines once realized when it proposed a simplified ticket pricing structure. Rationalized pricing might have helped the entire industry return to profitability, but the time was not yet right. Rather than adopting a similar approach, other major airlines continued to discount ticket prices, forcing American to abandon its plan.

Three Myths Behind The Power Shift

This dramatic shift in the power to control prices takes place because so many company leaders continue to believe that:

  • Price Cuts Gain Share — In fact, any share gain from price cuts is temporary, at best. Prices are highly visible and quickly lateralized, causing market prices to collapse.

  • Market Leaders Can Resist the Downward Pull — The traditionally dominant supplier often believes that its size, brand name, and recognition will keep customers loyal even as prices fall. This myth, which we call "The Leader's Trap," only prolongs the inevitable progress of market hostility.

  • Someone Here Must Be to Blame — Frustrated managers may believe that lower prices wouldn't be necessary if their staffs were doing their jobs well. "Why can't Marketing organize a good campaign." or "If only our sales force could sell." they may lament. In fact, while the onset of hostility may call for some internal changes, a company's staff cannot control this market-wide event.

Closing Thought

A leading company is often fearful that if it does not initiate price increases, prices will not rise. but the decision to raise a price that does not stick is not cost-free.

(Note: This Perspective was written in the context of the economy in 1994. While some of the companies may have changed their policies or indeed no longer exist, the patterns they exhibit still hold today.)


Recommended Reading

For a greater overall perspective on this subject, we recommend the following related items:

Analyses:

Symptoms and Implications: Symptoms developing in the market that would suggest the need for this analysis.