Developing a Price Advantage

Compting with Price

Competing With Price—
Smart Strategy or Business Suicide?

Can you achieve a true competitive advantage by having the lowest price in your market segment? And once you've established that position, can you defend it against price cuts by bloodthirsty rivals?

In my years of working as a consultant in and around highly competitive businesses, I've discovered some guidelines for using price as a means of maintaining or increasing market share. Following are a few of the lessons I've learned:

Do you have a structural cost advantage?
In order gain a true price advantage over its competitors, a company must have more than low prices. It must have a structural or fundamental cost advantage to justify such prices. Examples of a structural cost advantage might be favorable long-term purchase price contracts on raw materials, low overhead or lower shipping costs due to geographic proximity to markets. Low price alone (without correspondingly low production, purchasing or promotion costs) is a recipe for business disaster.

Barring unique circumstances, most firms operating in the same industry in a given location will tend to have pretty much the same cost structure. When one competitor cuts price as a tactic aimed at increasing market share and volume, others usually follow. This will act to erase whatever advantage the first competitor gained by reducing prices, leaving customers as the only winners.

Southwest Airlines enjoys a structural cost advantage by virtue of the fact that they fly just one type of aircraft-- the Boeing 737. (They also enjoy other cost advantages.) Most other competitors must maintain parts for, staff, fly, track and train for up to 5 or 6 different planes. Without a structural cost advantage, those competitor's ticket price reductions cause lower than average margins that only create more long term problems due to higher fixed costs. Lack of sufficient margins can negatively impact a firm's ability to invest in advertising, attract and retain key employees, carry on new product development efforts or build adequate cash reserves. In short, insufficient margins can put you out of business.

Are you offering value for the money?
Keep in mind that lower prices do not always lead to higher volume. Customers may value other attributes more than low price — for example, greater selection, longer product life, faster delivery, greater reliability, lavish after-sale service, better location, more attractive terms or reduced risk of defect. These attributes, when considered in terms of the product price, constitute what marketers refer to as "value for the money."

Also remember that low price merely increases the affordability of your product or service — not necessarily its value for the money. As an example, consider after-market automobile brake pads. These are a small and inexpensive part of your car relative to its overall cost. Lowering price may do little to increase demand for more brake pads. In fact, pads perceived as "cheap" may be seen as of low quality and potentially unsafe. On the other hand, low defect rates and greater reliability, communicated to customers via increased advertising, may increase the price automobile owners are willing to pay for pads. This scenario can then be managed to produce higher than average margins.

Higher priced competitors who deliver better value can defeat lower priced competitors who don't have a true cost advantage. A service firm expanded operations into evenings and weekends to increase capacity rather than lease additional equipment for daytime use only. This cost advantage was then used to increase margins, not lower prices, and the additional funds were used to hire, train and compensate better employees — who increased margins even more by doing higher quality work.

A strong defense
Defending against competitors' price cuts now becomes a decision based on the following questions:

1. Are you the low-cost leader in your segment who can dictate prices that weak competitors must follow, or are your pricing policies governed by high overhead, expensive labor and/or high-priced raw materials?

2. Is your competitor permanently lowering price, or just having a sale to reduce inventory? Are they attacking you armed with a true cost advantage or are they committing business suicide?

3. What other attributes does the market value? Can you counter by increasing the value you provide rather than simply lowering prices? Can you offer a greater value than the competition (at the same or a higher price) by providing faster delivery, an extended warranty, a free trial period or better interest rate financing?

4. Can you alternatively respond to price attacks by increasing your advertising levels, introducing new and improved products or immediately acting to improve your long-term cost structure?

5. Is your pricing policy part of a strategic plan, or something that is done in reaction to ever-changing situations? If you are simply reacting to moves by your competitors or the changing business environment, consider formalizing your policy as part of an ongoing strategic planning process.

Jim McCraigh

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