In free markets, competition is the norm not the exception, and that competition will limit your latitude for pricing. When competitors lower prices or new competition enters at a lower price, many a novice manager’s gut reaction is to lower prices, but the cost of price concessions may be higher than the cost of customer losses.
Experience will temper these beginner instincts over time, but there must be an easier and less costly way to identify the proper reaction to competitive price moves than the school of hard knocks. Perhaps we need a refreshed guide map on how to react and why…
The Wiglaf Competitive Price Reaction Matrix calculates the proper response to competitive price pressure. The principals of competitive advantage and pricing power define the dimensions. To win, the firm must merely earn more profits than its competitors. Second place goes to the survivors who will live to compete again in the next round. Losers are the firms that go under. Given these ground rules and objectives, we can identify the optimal moves dependent on the firm’s position.
Competitive Price Reaction Matrix
If the firm’s offer is more attractive to customers than its competitor’s, then the firm has pricing power. That is, the firm may be able to maintain or increase a positive price differential between its offer and its competitors without losing market share due to the customers perceiving that the firm’s offer delivers more benefits than its competitor’s.
If the firm’s profitability for the impacted customers is higher than the profitability which the competitor could achieve with those customers, then the firm has a competitive advantage. That is, the firm can use that competitive advantage to either attack a competitor’s customer base or defend its own customer base with a price reduction more profitably than one’s competitors during a price war.
There are four stances a firm should take in response to a competitive price threat depending on its situation: Ignore, Defend, Mitigate, or Accommodate.
If the firm both earns stronger profits in serving the impacted customers (possesses a competitive advantage) and customers perceive the offer as more attractive (possesses pricing power), then the firm should ignore direct price competition and carry on its strategy as it sees fit.
If the firm earns stronger profits in serving the impacted customers (possesses a competitive advantage) but customers do not perceive its offering as more attractive (lacks pricing power), then defending its market position with a measured price reduction may be merited. The margin reduction may be less costly than the potential loss of market share.
If the firm does not earn stronger profits in serving the impacted customers (lacks a competitive advantage) but customers do perceive the offer as more attractive (possesses pricing power), then the firm should mitigate price competition through reiterating and re-communicating its benefits.
Finally, if the firm both does not earn stronger profits in serving the impacted customers (lacks a competitive advantage) and customers do not perceive its offering as more attractive (lacks pricing power), then the firm will have to accommodate share and margin losses in the short term in the hopes of improving its value offering for the next cycle of competitive engagement.
Not all of the positions are equally attractive. But in real life, firms don’t always have pricing power and / or a competitive advantage, and they can’t win every customer profitably every time. But, they should be able to live to fight another day.