Why are some products priced the same even though different companies produce them? How do companies choose to price their products? What is competition-based pricing, and how does it work?
Unravel the secrets of the competition-based pricing method! Discover its definition, learn from real-world examples, and weigh the advantages and disadvantages of competition-based pricing. Whether you're a student or just curious about the marketplace, this engaging read will help you master the art of pricing in a competitive environment. Don't miss out on your chance to become a savvy pricing strategist!
Competition-Based Pricing Definition
Competition-based pricing is a simple way to set the price of a product by looking at what similar products from competitors cost. Businesses choose a price that's either lower, equal, or slightly higher than their competitors to attract customers. Competition-based pricing is standard for companies that produce goods and services that do not have strong brand loyalty and many available substitutes.
Competition-based pricing is a pricing strategy in which a company sets the price of its goods or services by considering the prices of competing products in the market, with the goal of attracting consumers by offering competitive or better value.
Imagine a neighborhood with three ice cream shops, all selling similar flavors. Shop A sells a scoop for $3, Shop B for $3.50, and Shop C for $2.50. To attract more customers, Shop A might lower its price to $2.75, positioning itself between Shop B and Shop C, offering better value than Shop B while maintaining a perceived higher quality than Shop C.
Competition-Based Pricing Method
Utilizing the competition-based pricing method involves setting prices by considering factors such as rival strategies, costs, and market offerings. Customers often determine a product's value by comparing prices other businesses charge for similar items.
To effectively assess competitors' pricing strategies, a company must ask several key questions:
How does the company's market offering compare to competitors in terms of value provided to customers?
- If customers perceive the company's product as more valuable, it may warrant a higher price.
- If the product is seen as less valuable, the company can either reduce the price or work to change customer perceptions to justify a higher cost.
Is the company facing numerous competitors with high prices relative to the value they offer? If yes, the company can adopt lower pricing to force less capable competitors out of the market.
Is the market is dominated by larger competitors with lower prices? If yes, the company can target underserved market niches by offering value-added products and services at higher costs.
By mastering the competition-based pricing method, businesses can effectively position themselves within the market and attract customers seeking the best value for their money.
For example, assume that General Motors (GM) is ready to release a small SUV designed for off-road use, which will compete directly with the existing Jeep Wrangler and Ford Bronco. Since it has been many years since GM produced a similar SUV, analysts assume that buying decisions will primarily be made on price rather than brand loyalty. GM looks at production costs for its new SUV, determines the minimum price it can charge, and receives a sufficient return on investment (ROI).
Of course, GM does not want to charge only the minimum price. To engage in competition-based pricing, it compares the features it will offer on its new SUV with the costs and features of its substitutes, the Jeep Wrangler and the Ford Bronco. GM analysts determine that the base model of its new SUV offers 85 percent of equal parts to the base model Ford Bronco and 75 percent of similar features to the base model Jeep Wrangler.
To price competitively, GM decides to set the price of its new base model SUV at 80 percent of the cost of the latest base model Ford Bronco. GM tries to maintain the same proportionality for models above the base model.
Competition-based pricing is only successful if the firm can compete with its rivals on production costs.
For example, GM's cost of production may be too high for it to price its new SUV at 80 percent of the cost of the substitute Ford Bronco. If this is the case, GM may have to cancel the SUV or try to market it using brand loyalty rather than market it based on low pricing.
This may be possible for an established company like General Motors but is unlikely to be effective for a new firm trying to break into the market that has developed little or no brand loyalty.
It is important to note that the objective is not to equal or beat rivals' pricing. Instead, the aim is to establish pricing following the value generated compared to that of competitors.
Competition-Based Pricing Example
An example of competition-based pricing includes analyzing competitors' prices and then setting a similar but slightly lower price for one's products. Sellers do this by keeping track of rivals' prices through market research. Research can also include tracking price changes over time to analyze trends, such as the costs of certain goods rising or falling based on seasons. Let's take a look at the two most famous examples of competition-based pricing.
Coca-Cola vs. Pepsi
Disadvantages of Competition-Based Pricing
Competition-based pricing comes with disadvantages. Competition-based pricing can be complicated if there are few substitute goods upon which price comparisons can be made. This will put new entrants at a disadvantage, as they may not know where to set a competitive price. A mistake in pricing made upon market entry can quickly hurt a company, as potential customers hold firm to first impressions. Even quick changes in "incorrect" prices may not be sufficient to save a product. Let's take a look at the most important disadvantages of the competition-based pricing
Price wars
Competition-based pricing can lead to price wars, where companies continuously lower their prices to outdo each other, which can result in reduced profits. For example, the airline industry has experienced price wars, leading to lower ticket prices, but also diminished profitability for some carriers.
Price wars typically occur when one firm lowers its price and customers abandon rival firms to seek the lowest price.
Because rivals are losing customers, they also have little choice but to reduce their costs. This can result in the initial price-cutter reducing its prices even further, hoping to continue luring away customers from rivals. The process can continue in a perpetual downward slide in prices. While this may seem great for consumers enjoying regular discounts, it can harm the market overall if it ends up driving some firms out of business.
Price wars that drive firms out of business can raise average prices in the long run due to reduced competition. Price wars are usually pursued by the dominant firm in a market with the lowest production costs due to its larger size and better economies of scale. Once it has driven its smaller rivals out of the market, the dominant firm can raise its prices above where they were when the price war began. This action is often known as predatory pricing and is illegal.
Large retailers like Walmart have been accused of predatory pricing when entering new markets, using their size advantage to undercut the prices of local rivals. Once the rivals have been driven out of business, the chain retailer can raise its prices.
Collusion risk
In some cases, competitors may engage in illegal collusion, secretly agreeing to set prices at a certain level to avoid competition. This can lead to artificially high prices, harming consumers and potentially leading to legal consequences for the colluding companies.
Fortunately, collusion is less common than is often expected, as firms are incentivised to cheat on the collusion deal. If five large firms collude to set a higher price on a similar product, the first firm to break the agreement and charge a lower fee will win over most customers in the market. This can trigger a price war that harms all firms' profitability. Thus, firms tend to be reluctant to collude on price.
Neglecting non-price factors
Competition-based pricing can cause businesses to focus too much on price and overlook other important factors, such as product quality, customer service, and brand reputation. For instance, a company might lower its prices to compete with a low-cost competitor but inadvertently harm its brand image by compromising on product quality.
Ignoring cost structure
Basing prices solely on competitors' pricing may lead businesses to ignore their own cost structure, resulting in unsustainable pricing strategies. For example, if a company has higher production costs than its competitor but still tries to match its prices, it may struggle to maintain profitability.
Advantages of Competition-Based Pricing
There are several important benefits of using competition-based pricing. Let's take a look!
Attracting price-sensitive customers
By offering competitive prices, businesses can attract price-conscious customers, increasing sales volume. For example, Walmart's "Everyday Low Price" strategy attracts customers looking for the best deals on everyday items.
Simplified pricing decisions
Basing prices on competitors' pricing allows businesses to focus on the market and reduce the complexity of pricing decisions. For instance, a small retail store may set its prices by monitoring the prices of similar items at nearby big-box stores.
Adaptability
Competition-based pricing helps businesses stay agile and adapt to market changes quickly. For example, if a competitor lowers their price, a company can respond promptly by adjusting their own prices to maintain competitiveness.
Consumer benefits
Lower prices resulting from competition-based pricing enable consumers to afford more necessary goods, such as groceries, gasoline, and other high-demand items. This approach caters to price-sensitive customers and helps increase the accessibility of essential products.
Reducing market entry risk
Competition-based pricing helps new businesses gauge the prices that customers are willing to pay, reducing the risk associated with market entry and expansion. By understanding competitors' accepted prices, new firms can strategically position themselves for success in the market.
Competition Based Pricing - Key takeaways
Competition-based pricing involves adjusting one's prices based on competitors' prices.
To engage in competition-based pricing, firms look at the prices of substitutes available on the market, both currently and historically.
Competition-based pricing is common in the automobile and smartphone industries.
Competition-based pricing can be complicated if there are few substitute goods upon which price comparisons can be made.
Price wars typically occur when one firm lowers its price and customers abandon rival firms to seek the lowest price.
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