The other day I heard someone refer to pricing as the bastard child of marketing. Why? Because pricing takes as much nurturing, if not more, than any other marketing tactic but generally doesn’t get the superstar recognition of an advertising campaign or new product launch. And yet, as we saw in ‘How To Set Prices To Seriously Increase Profit’, we should recognize pricing for its true relationship to profit – a key lever in driving your company’s bottom line.
Welcome to my series’ second blog post on different types of pricing strategies. We have covered Cost Based Pricing and have come to the conclusion that it is a myopic strategy because of its failure to consider important external influences as an internally focused strategy.
This post is dedicated to Competition Based Pricing Strategies. In essence, we are now venturing into the marketplace and legitimizing our position versus other competitors.
What is Competition Based Pricing?
In this methodology, competing products are used as a benchmark for how to set your prices, rather than using your internal costs, customer demand or brand development as key factors for price determination. This can be a simple and effective approach with the following options:
We feel able to charge some premium versus the competition because our product has attributes the purchaser values over the competition. These attributes may be real, as in the case of a concentrated soap that may deliver x% more volume of clean clothes, or perceived, as in the case of the luxury writing instrument. Presumably you have a sense of how much the attribute(s) are valued to enable you to set the premium. In the example below, the premium to the competition is $2/ unit, or 20%.
Competitive or Parity Pricing
In markets where there is little differentiation or a commodity orientation, competitors are often priced the same.
Here we may adopt a price leadership strategy either because our product lacks certain attributes, or because we believe that the market is price sensitive. Simple analysis would allow us to determine payback for this strategy.
The above examples are meant to look at regular pricing versus the competition executed on a day-in-day-out basis. Another approach to competitor based pricing would be:
High – Low Pricing
This strategy positions the list price higher than the competition and discounts are later applied to tactically deliver a more competitive price point. Purchasers tend to peg the product value at the list price and ultimately feel they are receiving tremendous value by buying at the discounted price. North American car manufacturers often employ this approach, with discounts of $10,000 or more on some models.
While Cost Based Pricing is internally focused, Competition Based Pricing takes into consideration some important external influences. However, there are pros and cons for this approach.
Pros of Competition Based Pricing
- On the positive side, this pricing strategy is relatively simple and easy to execute. This is particularly true in industries with few competitors, not many channels of distribution and/ or limited differentiation between products. Just follow the competition and tweak as necessary.
- I also like the low risk element of this strategy since you’re not likely to lose volume and market share by following this approach.
Cons of Competition Based Pricing
There are also inherent weaknesses to this strategy…
- Who says the competition knows what they are doing? In my experience, many marketing and sales people tend to view the competition as all-knowing, particularly in tough market conditions. I’m not saying we should underestimate the competition but perform some due diligence.For example, consult with your friends in accounting and make sure you understand your costs. Do the competitive price points you are seeing make sense relative to costs? Are competitive prices consistent across customers in a particular geography? You need to do reality checks since this approach is akin to delegating your pricing decisions to your competition.
- If the competition is also using this approach, the entire industry may have stopped thinking. Once a ‘market order’ has been set, there could be a reluctance to change prices resulting in limited (price) competition. Complacency will yield inadequate understanding of true market demand and ultimately missed opportunities. For this very reason, I’ve learned to endure the pain of potentially trading away up to 5 per cent of the business each year while testing pricing limits. Of course, this kind of testing can also yield you an upside in revenue potential.
Competition Based Pricing is a viable option for many businesses, particularly those where there is limited differentiation between products. I believe this approach to be superior to Cost Based Pricing as it moves us from an internal focus to more of an external or market orientation.
Our pricing journey is becoming more interesting with the added complexity of external factors; we should recognize that this work is every bit as challenging as developing an advertising campaign or a new product. And in the same way, it requires focus and process to deliver upside potential.
Our next blog will take us further into a discussion of market dynamics, as we look at Customer Based Pricing strategies.