In the early 2000s, a growing technology company was faced with increased competition from lower-cost providers. In a bid to appeal to a younger demographic and defend its market share leadership, the company reduced the price of its services by 20%. The result? A negligible increase in volume and a 13% reduction in average yield. In addition to attracting more fickle customers, competitors reacted by lowering their prices, negating the intent of the original pricing move.
While this company’s intentions are laudable, its experience highlights the challenge of price leadership. Far from being simply the first to take action, a true price leader is able to consistently execute pricing actions that result in a desired effect. Much like in a game of chess, a pricing leader devotes the time and resources to understanding the motivations and aspirations of its competitors and to building the skills necessary to think several pricing moves into the future. While market share leaders often try to take on the role, they are frequently prone to thinking of their own narrow interests.
We often see these dynamics played out in a pricing game that we run with our clients. In the exercise, a room of participants is divided into several teams, each representing a different beer company. The teams are asked to determine product prices using one of several strategies: profit maximization (highest price), risk minimization (mid-tier price), and transactional maximization (lowest price). The teams then announce, in turn, the price of their beer in a series of rounds. Throughout the game, instructions are given that increase the competitive dynamic in the room.
Invariably, one of the teams attempts to play the price leader and sets its prices for profit maximization, confident that its competitors will follow. This team is often surprised when its competitors choose a different strategy, driving prices down and upsetting the overall profit potential in the beer market. The true leader in this game is the team that lowers price and maintains its stance until the others follow suit. The lesson here: One is not a leader unless others follow. The trick is to determine how to prompt competitors to follow in a way that works in your favour. Of course, these dynamics are also true during periods of rising prices.
Ultimately, the most effective way to lead in pricing is through innovation and a dogged determination to addressing customer needs. For the technology company mentioned above, a commitment to pricing excellence was integral to the innovation needed to right itself. First, the company established a pricing department and adopted guidelines designed to thwart pricing missteps. It then deepened its industry and competitive knowledge through targeted research and price testing. Armed with new insights, the firm revamped its approach to customer segmentation and developed a new pricing structure that returned it to previous profitability levels.
The economic crisis soon tested the firm’s pricing capabilities. Using its robust pricing intelligence, the company successfully fended off calls for price reductions and began offering value-added products to discreet customer segments. Competitors that had once been quick to adjust prices down began following suit. This story demonstrates the benefit of taking pricing to heart and the stability that a firm can provide to its industry by learning to be a true price leader.
Note: This story originally appeared in The Financial Post on July 27, 2012.