Competitive based pricing: Are you falling into the commodisation trap?

Are you in control of profitability or are your competitors the ones driving your profitability? 

 

Many businesses implement competition based pricing strategies and tactics based on the assumption that the price of their products and services is set by an equilibrium in the market i.e., that the market will eventually decide the right price for your products and services.

However, applying this traditional economic principle into 2017 when markets are extremely volatile and highly competitive is fraught with risk and will lead to inevitable margin erosion and commodisation.

  1. Market equilibrium is constantly shifting. Most business do not have advanced price analysis and/or competitive pricing intelligence systems (or even mindset) to track, monitor adjust to key shifts in market.
  2. Today’s pricing teams are still largely focused on price administration and in turn struggle to interpret patterns of variability in the market that would otherwise drive profitability for the business.
  3. Business and pricing strategy tend to be based on simplistic cost plus and competitive pricing methodology that often fail to explain the differences in revenue and margin by product and customer segment.

Classical economic theory was fine when markets were more stable. In 2017 and onwards we need to adapt our thinking and break away from routine economic and management principles. 2017 is about gathering multiple market sources and understanding sophisticated pricing principles to explain pricing power in complex and changing pricing environments.

In this article, we will evaluate competitive based pricing and identify the possible difficulties you may face as you develop your competitive pricing strategy for each segment and product.  We also provide a series of recommendations and alternatives throughout this article to help you and your team think beyond the day to day tactics of competitive pricing setting scenarios.

What is competitive based pricing?

Competitive pricing basically means setting your prices at the same (equivalent / parity pricing), slightly higher or slightly lower than your competitors. Your pricing team will set an initial item price by examining a competitor’s or group of competitors’ prices – this process is known as competition based pricing.

Competitive based pricing is complex: Case study Coca Cola

In a highly competitive market, it is often the case that when you start the competitive based pricing process you will find multiple prices for an item product or service. Large variation in price created by competitive based pricing is otherwise known as price dispersion. An example of price dispersion resulting from competitive pricing is Coca Cola (see interesting article on the early pricing history of Coke).

Coca Cola operates in a highly competitive market consisting of similar and substitutable products. Coke as a single item can be bought for $0.59 or nearly as much as $5.00. There are a number of price points for Coke in the marketplace (even between neighbouring retail stores) and yet product remains unchanged even after years and years of production.

If we assume that the B2C Coca Cola pricing team in APAC is implementing competitive based pricing for Coke, then Coke’s competitive pricing process would begin, for instance, by trawling through large amounts of competitive price information and data available to determine the initial price point for competing retailers across multiple segments.

If we also assume that the APAC Coke pricing team does not have pricing software tools to automate their competitive pricing process, then the above competitive pricing process would be largely manual, requiring pricing analysts to input and change prices weekly or monthly in the system to remain competitive in the market.

The Coca Cola case study above illustrates the administrative pricing complexity associated with competitive pricing. We commonly see pricing teams devolving into reactive and operational decision making because they are tracking the competitors so closely that they do not have time to think about the wider market and positioning. Simply managing price dispersion created by competitive pricing across segments and products will reduce profit.

Key pricing questions: What are the drivers of pricing power for Coke? Does the market really control pricing power for Coke or it is something else driving price?

Resolving pricing complexity with a competitive pricing strategy

Often pricing teams get around the complexity of vast competitive price information by focusing on only the highest marketplace prices, on only the lower or only on the middle of the competitive price range. Some business also select a group of competitors and apply the above competitive pricing method of setting their initial prices by product and segment.

In all cases, it is important for pricing teams to supplement their competitive pricing methods with customer and competitor information such as costs, strategies, elasticities, profit levels and others elements of competitive pricing intelligence. However, most business have large gaps in their data architecture and analytics and cannot generate meaningful insights on either the customer or the competitor. Consequently, businesses are forced to make assumptions about their competitors and consumer behaviour without fully qualifying and validating this with evidence.

The problem with a competitive pricing strategy

When businesses do not have enough information to supplement and qualify their assumptions on consumer and competitive behaviour, they tend to assume that that their competitors are like them. Consequently, pricing options (and understanding of trade-offs) become limited by their own match to market thinking.

However, what if your competitors know even less about the impact of pricing on the market then you? What if they don’t have an accurate gauge on their cost base? What if they do not understand their customer base and/or demand pricing and are actually following you? Every business is different in terms of their CAPEX, supply and strategy & vision for the future. Don’t assume your competitors are like you.

Conclusion

Competitive based pricing strategy and tactics can often miss the subtle variations in the market and in turn do not always account for the differences in revenue, contribution margin, cost to serve, value by segment and product.

A highly manual competitive pricing process and static pricing model based on basic market assumptions and arbitrary price differentials will expose the business to risk in highly transparent markets.

A competitive pricing strategy and tactical program is reliant on a sophisticated price ecosystem: i.e., sophisticated price data architecture, centralised analytics, pricing optimisation algorithms, a robust competitive intelligence tools, a sophisticated value based segmentation framework and a high performing pricing team. Even if 1 of these pieces are missing, profits will decline.

Once your price ecosystem is set up properly, make sure your team is given the tools and techniques to think strategically. Even tactical teams need to think strategically in order to produce viable price options for each segment and product category.

If you decide you want to build a team based on a competitive pricing process, we recommend 1 pricing manager and 4 supporting analysts for every $500M+ to manage and implement effectively the competitive pricing review & associated price information and follow up implementation plan.

If you only implement competitive pricing methodology in your business we highly recommend broadening your skills and knowledge base with alternative pricing options; most notably customer and value based pricing methodology and price optimisation analytics.

 

See our blog on why price gouging is nearly always a bad idea.

 

For yet more on Coke – see our blog on price acceptance when reducing can sizes.