I don’t use Uber often, but our family recently used it to take us to the airport. When we returned, we just walked outside the airport and hopped in a taxi. The price of the Uber ride ended up about 35% lower than the price of the taxi. That is not news. It has been widely discussed that Uber generally offers lower non-surge prices than taxis, and the service has grown very rapidly, in part at the expense of taxi companies. So is that a model that other companies can follow – offer lower prices than the market leaders to take share and grow quickly? The answer is sometimes, but not often.
Let’s think about some examples. In the early 80’s People Express launched one of the first budget airlines. Prices were low and service was poor. They grew for a while, but on common routes full-scale airlines lowered prices to match People’s and People Express eventually died. Other budget carriers tried similar tactics over the years, like Jet America, Air Florida, PSA, etc. and all went out of business. Not learning much from that, the major airlines occasionally launched price reductions to capture more share, but their prices were quickly matched by competitors and everybody lost in the price wars. Southwest was really the only US-based discount airline that thrived. They succeeded because they had a much lower cost structure than the major carriers and could make money at lower fares, they offered a very efficient service, and they did not compete head to head on the major carrier’s busiest lanes. And today, Southwest is no longer the lowest priced airline.
Dell Computers was formed in 1984 with low-priced customizable personal computers. Dell had the best supply chain in the industry and grew rapidly by offering PCs and laptops at prices IBM, HP and others could not match. Over time, however the other PC manufacturers improved their supply chains and cost structure sufficiently to match Dell’s prices. It is now a low-margin industry for all.
In the late 90’s and early 2000’s a number of startups took on the retail industry with low-priced dotcom businesses. Amazon.com, which started as an online book seller, has been the most successful and is now an enormous ecosystem on its own. Most of the other dotcom businesses could not make money at the low prices and have gone out of business.
Apple started iTunes in 2001, offering single songs at a price of $0.99 each. This was cheaper than the price of a single song on a record, which nobody purchased anymore; and it was significantly cheaper than buying an entire CD. However, the songs could only be played on Apple devices. They had access to a huge library, and purchases were easy, so Apple quickly created their own ecosystem for music.
More recently, it was reported that Merck had priced Zepatier, a Hepatitis C drug, to undercut Gilead’s Sovaldi and quickly grow volume, Merck’s ‘aggressive’ hep C pricing helps it steal share in Q1. Based on the report, it appeared that Merck’s pricing strategy worked. But for how long? Now Gilead is fighting back, Gilead notches FDA approval for first all-genotype hep C med, Epclusa, offering an alternative drug combination at a lower price point. Sovaldi remains the market leader and Epclusa is expected to grow rapidly.
Those are just a few examples and they are a mixture of successes and failures. However, we can learn from these examples to see the elements needed to make a lower price strategy successful.
- A sustainable cost advantage versus competitors is critical. If products or services are comparable and entrenched competitors can simply match your price, they will. The result is a price war. However, companies with a durable cost advantage like Southwest can make money at lower prices than their competitors. Remember that a cost advantage can be eroded over time as labor contracts change and competitors get more efficient.
- Sometimes lower prices can generate enough new demand to build an ecosystem like Apple. iTunes and the iPods were priced low enough to create complementary demand for each other and build that ecosystem. Amazon has done the same thing with low prices on products and shipping to get people buying, then adding sellers and products to develop the ecosystem.
- Demand is highly elastic and a low enough price can sufficiently stimulate demand to lower overall per unit costs. Netflix is a good example of relatively low prices stimulating substantial new demand, improving profitability by spreading fixed costs over a much larger base.
These conditions for a successful low-price strategy apply to ongoing markets and pricing. In addition, there are situations where temporary promotional pricing can be effective without destroying long-term value. However, most efforts to gain market share with lower prices fail. Be careful to understand which situation you are really in before making an aggressive low-price move.
Setting market place precedence has extinguished many a grand plan to buy market share profitably and can result in the elimination of many jobs when GM$ grow while CM$ dwindle. I have first hand knowledge having been hired on to build and release an automated pricing authorization system. It was successful and complete with all the necessary metrics and business case information needed to make executive level pricing decisions easy. The company was not the captain in the sector and sold high quality ‘Cadillacs’ for products. The competition had a much better cost position buying containers of turnkey product from overseas. While pleading with Sales and the powers that be not start a price war, they bought market share. The R&D/Marketing folks who were responsible for these products would not approve the pricing on these deals. However, Sales would “sell” in the Executives and hence they were overridden continuously. While the system worked excellently, in the end I was asked what the ROI was for the system expense. What could I say? “It showed us how much money we lost”? The company was run well at the core but it bought too much share too fast.