A friend, also named Scott, recently sent me an article Leading the Way that discussed the frequency of small lubricant competitors leading the way in price changes. The article, originally published in Lubes’n’Greases magazine demonstrated that independent producers increased prices of lubricants as frequently or more than the major producers. The article reminded me you don’t have to be the largest competitor to be a price leader.
Amazon announced recently they will no longer offer price match refunds on televisions. That follows Amazon’s decision last year to eliminate price matching on other items. They are not the first and they won’t be the last to start or stop matching prices. It raises a question we hear often – should your pricing strategy include the promise to meet or beat competitor prices? From our perspective, the answer is generally no, but it depends on the circumstances.
Now that Donald Trump has been elected to be the next President of the United States, companies are looking at his campaign promises and cabinet appointments to assess what it means for their business. In particular, companies are anxious about how a Trump Presidency will affect their cost of doing business. This is all happening at a time when many companies are setting their base prices for 2017. My advice is to remember that pricing is not a cost-based exercise. Your pricing strategy should be aligned with how you compete and how you provide value to your customers. Consider whether your customer’s perception of value could change, and if so by how much. Let that guide you in setting prices.
So far there are indications a Trump Presidency can be both positive and negative for business. On the positive side, it appears we can expect:
- Fewer regulations affecting hiring, construction, and business creation
- Potentially lower health insurance costs
- Potentially some protection for US manufacturers from renegotiated trade agreements
On the negative side, we might expect:
- Higher costs on imported components and supplies from new tariffs and renegotiated trade agreements
- Potentially higher tariffs from countries to which US manufacturers export
- Higher labor costs from restricting immigrant labor
- Punishing companies that try to lower their costs by opening plants in other countries
We frequently tell our clients, “Your customers don’t really care about your costs.” While they recognize that you may feel the need to pass on changes in your costs in the form of higher prices, your customers really care about how their own businesses or livelihoods are affected.
With that in mind, consider your customers’ next best alternative. If you and all your competitors are experiencing the same cost changes, you can probably expect consistent reactions from your customers. That is, if the costs of imported products have increased due to higher tariffs for all competitors, your customers may grudgingly accept price increases. However, you can also expect those customers to explore their options.
The opposite situation might be one where you and all your competitors are not affected by imports or exports, but your costs decrease because of reduced regulation and lower health insurance. (Okay, maybe that is just a dream.) There is no reason to automatically lower your prices. The value you have been providing your customers has not changed. Unless they have some new, alternative that lowers the value equation, keep your prices where they are.
The most likely scenario is you are competing with domestic and global competitors, and the impact of the Trump administration will be inconsistent. In that case, consider the problem from the customer perspective and work backward. Before considering prices, try to quantify how your product or service affects your customers’ results. If you enable customers to generate revenue or control their costs more efficiently than they can with the best alternative, quantify how much that is worth. Then make sure that is aligned with your prices.
If your prices are already aligned well with your customers’ value equation, don’t try to raise prices just because your costs increased. On the other hand, I find that client prices are not always aligned with the value equation and they actually have a little room to raise their prices. Make sure you do the math, though. Raising prices when there is not a supportable value difference can frequently cause customers to defect.
If you are in a position where your prices have been competitively aligned, and your costs are increasing faster than your competitors – find another way to adjust. Look for a way to add more value and disrupt the current offerings, or look for options to get more efficient in providing your products and services. Perhaps you can capitalize on lower indirect costs from reduced regulation or lower health insurance costs to offset the costs that are increasing.
The point of all this is to avoid the knee-jerk reaction of changing prices in step with your cost changes. Your pricing strategy should be determined by the value you provide, not how much it costs you to provide it. There will probably be changes in your cost structure resulting from Trump Administration policies, but letting those changes dictate your prices could make your results worse instead of better.
After getting raked over the coals by Congress earlier this year, Mylan is preparing to release a generic version of their EpiPen, Mylan To Start Selling $300 Generic EpiPen Pack Next Month. The price of the generic will be roughly half the price of the brand name EpiPen. That raises obvious questions like, “How will the generic impact the sale of the EpiPen?” and “What will happen to Mylan’s profitability?” Although the Mylan issue is a bit extreme, these are similar questions to those that must be answered by any company whose pricing strategy includes offering a generic version of their product or an introductory level version of another product. All of the strategic aspects of introducing a low-priced offering must be explicitly considered and planned.
Customers are not all the same. They have different levels of price sensitivity and often experience different levels of value from a given product. The whole point of segmentation is to identify which customers fit into logical groups with common levels of value and common levels of price sensitivity, and then create offers that fit each segment. We see it with automobiles, such as Mercedes which offers an entry level, middle tier, and premium tier of their 4-door sedan. We also see it in HP laptops with devices aimed at basic users, gamers, power users, and multiple steps in between. The products in the lineups of Mercedes and HP have a range of prices and a range of features to address multiple customer segments.
An important point is companies introduce 2nd, 3rd, and 4th versions of products to capture additional customers. If a company’s first version of a product starts at the premium end, future versions are likely to be descoped versions to appeal to customers who are currently not buying. The purpose of the reduced-price version is to capture more price-sensitive customers, or those who do not need all the features of the original, not just to lower the price for existing customers. Conversely a company who starts at the lower end of the spectrum would offer a premium version to meet more advanced customer needs and capture premium prices.
The next important point in these lineups is the products are not simply the same thing with different names. There must be differences. The highest end products have features that add more value compared to the lower level products. The manufacturers communicate those extra features and the additional value to customers and prospects, along with communicating the higher prices.
Generic items market themselves as products that provide the same value as the brand-name products, but at a lower price; and brand names compete by touting their quality, reliability, safety, and special features. In other words, not the same thing. Mylan appears to be trying to market their generic EpiPen by saying it is the same thing as their own brand name drug. If customers perceive a Mylan’s generic product is identical to the brand-name product, a large percentage of those customers will simply switch to the generic version. That will significantly reduce Mylan’s revenue.
For any company looking to expand their customer base by offering a generic or entry-level product, they need to address:
- How large is the market for a generic version of the product?
- How many existing customers are likely to switch to the lower-priced version?
- Can we articulate the differences between the premium product and the generic product in a way that demonstrates value?
- How many new customers are likely to be captured with the new product?
- Does the profit increase from new customers offset the profit decrease from customers who simply switch to the lower-price version?
- How are competitors likely to react?
In Mylan’s case, there were already many complaints that potential customers had been priced out of the market and could not buy EpiPens. In addition, a new competitor will be entering the market, and the new competitor will likely capture some existing Mylan customers and compete for the more price-sensitive customers. So, Mylan needed to act.
For most of Mylan’s existence, they have manufactured generic drugs and sold them as equivalent to the branded versions. With the very large price increases they implemented, they should also have been planning for a path to address the more price-sensitive segments. Without some identifiable differentiation, customers will know that their new generic EpiPen is the same as the branded product. I expect the revenue and profit from EpiPens will fall dramatically. More modest price hikes and better planning could have avoided the coming profit decrease.
Real monopolies are rare. There is competition for everything. That does not mean most products or services are commodities. I have often heard executives say, “We sell commodities, and price is what matters.” They then set their pricing strategy around winning with low prices, but in reality anything can be made special. Is there anything more basic than water? It covers nearly 3/4 of the earth and the average person uses between 40 and 200 gallons each day, at a price of a fraction of a penny per gallon. However, water has become highly differentiated and the prices we pay for it vary widely. For example, I looked at some bottled water prices at Amazon.com (24 packs unless otherwise noted):
- Member’s Mark – $.05 per ounce when bought in bottles of 8 ounces
- Nestle Pure Life – $.012 per ounce
- Dasani – $.044 per ounce
- Poland Spring – $.032 per ounce by the liter
- Smart Water – $.035 per ounce in 6-packs of 1 liter each
- Fiji – $.053 per ounce
- Evian – $.062 per ounce
The most expensive brand is 5 times the price of the cheapest. And the 2nd most expensive is more than 4 times the price of the 2nd cheapest. Isn’t water a commodity? In some respects, water is a commodity, but these well-known brands have widely different prices. How can they succeed like that? Each brand communicates to their customers how their products are different. They sell the experience, cache and unique features of their water; and they sell at these prices at Amazon shoppers who are among the most price sensitive anywhere.
In a similar quick study, last winter I compared the prices of gasoline at gas stations in Palm Beach Gardens, FL. Once again, gasoline is often considered a commodity. If your car takes regular gas, any gas will work. However, in my study there was a 30% difference between the price of the cheapest and most expensive gas within a 3-mile radius. All of the stations had customers filling their tanks. Clearly the lower-priced stations view themselves as commodity sellers that must compete on price. The higher-priced sellers believe their customers make purchase decisions based on criteria other than price, such as location, convenience, in-out access, cleanliness and service.
Lipstick is another product often thought of as a commodity. It is a relatively straight forward mix of chemicals. Revlon does not think of their products as commodities, though. Charles Revson, the founder, once said. “When it leaves the factory it is lipstick. But, when it crosses the counter in the department store, it’s hope.” Their prices reflect the value of that hope.
It is important to all of us to think about what makes our businesses unique rather than simply assuming we are just like the rest of the crowd. As sales people, executives, and representatives of our companies, we need to communicate to our customers how we add value as a provider, how we add value as individuals, and how we are different from our competitors. If we treat our customers as special, follow up relentlessly, and they believe they are our most important customer, we can win in a crowded market. And when we do that, we have a much better opportunity to differentiate our prices and a much better opportunity to reach our goals.
Last month I wrote a post, When to Use Low Prices to Grab Market Share, in which I described situations where that pricing strategy worked and where it didn’t. Recent earnings releases have provided new clarity about the perils of discounting as certain restaurant chains, retailers and manufacturers have suffered stock declines primarily because of margin squeezes. Price wars are inevitably painful for everyone.
Whole Foods reported decreased earnings for their 2nd quarter although sales for the quarter had increased. The cause was continued price reductions resulting in same-store-sales declining 2.6%. Whole Foods’ stock price decreased by 8% following their earnings announcement. (See Whole Foods stock sinks after key metric disappoints Street)
More recently, Motley Fool wrote The race to the bottom is hurting fast food, specifically citing McDonalds, Sonic, and Yum Brands suffering lower earnings as a result of severe price competition. Earlier in the year, Wendy’s had also reported depressed same-store comps. Motley Fool went on to describe a “restaurant recession”, fueled in part by companies aggressively competing for the most price-sensitive customers.
This week a New Zealand manufacturer of toiletries, Asaleo Care, experienced a 30% drop in their stock price when they cut their profit guidance for the year. (See Asaleo Care slashes guidance as profit slumps.) Asaleo specifically cited increased discounting from competitors reducing their own prices and causing increased trade spending to protect market share.
All of these results are huge disappointments to the investors and management teams of these companies. Unfortunately, they are also very predictable results of price wars.
We can contrast those negative results with PulteGroup, Inc. Pulte’s stock jumped 10% in the first few days after reporting earnings that beat Wall Street estimates, PulteGroup (PHM) Tops Earnings & Sales Estimates in Q2. In the earnings release, Pulte reported an 11% increase in the average selling price (ASP) of homes. Although the housing industry has improved the past few years, Pulte identified strategic pricing initiatives as being the biggest driver of the improvement.
None of these examples by itself is proof of anything. In fact, I have written blog posts in the past cautioning against relying on one or a few examples, Be Skeptical of Anecdotes – Use Your Data. However, the examples are more corroboration for the evidence I used last month against competing on price. Unless you have a long-term sustainable cost advantage, discounting prices to gain market share leads to price wars that nobody wins.
One other important point – sometimes you may not have much choice. If one or more competitors decide to try to take your customers by lowering prices, you have to defend your business. Most of the time, that means more clearly demonstrating the value of your product or service compared to the competitor, but sometimes it means lowering your price. Even if you have a superior product or service, a destructive competitor can lower prices enough to distort the value equation in your industry; and when that occurs you have to adjust. In those cases, be careful not to accelerate a downward spiral of prices. Defend with price where you need to, but make sure your messaging is focused on those traits that make your product, service, and company unique. Continue to articulate the value of doing business with you, rather than talking about price.
It has been written many times that nobody wins price wars. They are just painful for all the participants. Discounts, when properly used to reflect the value to certain segments and customers, can be effective if managed. But they are perilous. When used recklessly or extensively, they can destroy the value of your business.
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.
In discussions with clients or prospective clients, we are often asked if our work is driven from monitoring competitor prices. In our view, an understanding of competitor pricing strategies and competitor behaviors is a helpful piece of the puzzle, but it is far from a complete answer. Competitive analysis is information that supplements insights from your own data and understanding of your strengths and weaknesses, and it contributes to an understanding of how you can compete and win in your chosen markets. However competitive analysis and competitor price monitoring are not strategies.
Customers decide what to buy and where to buy based on a number of factors, only one of which is price. I was reminded of this on a recent trip to Florida during which I observed a wide range of gas prices at service stations within a small area. In fact the highest price I observed was 30% higher than the lowest price and 9% higher than the median. And in spite of those price differences it appeared that all of the service stations were busy. So matching prices would not have helped the high-priced guys.
Price monitoring software and services are widely available today, particularly for retailers. The tools are sophisticated and enable the users to track a wide variety of competitors and products. The theory behind the tools is many customers use the internet to compare prices, and if your prices are too high, you will lose sales. But even with that price transparency, customers are not buying solely on price. If they were buying only on price, higher-priced retailers and the Florida gas station with the 30% premium would quickly go out of business.
There was a recent post on LinkedIn, Digital Dynamic Pricing – “Dark Side of the Force”?, in which the author argues that following competitor pricing with automated tools is a zero sum game and lowers overall profitability. If all retailers can instantly or quickly match competitor price moves, there is no advantage to be gained by lowering prices. It quickly becomes a race to the bottom. In addition, the author points out that most companies do not actually measure whether the price moves have an impact on demand. And when they do measure the impact, the results can very often be random variation rather than price-driven variation.
There is no doubt that customers use tools to help learn the prices retailers are charging. But prices are only part of the buying decision for customers. There are other factors that are usually more important to them, for example:
- How well the product or service meets their needs, which often includes the ability to see and touch the product before buying
- The level of service provided by the vendor or retailer
- The ease or convenience of purchasing, or even the desire to support local businesses
- Loyalty programs that create incentives for repeat business
Consumers may check the price of something online while they are physically in a store, but then pay more than the online price because they can get the product instantly in the store. If a store tries to compete by matching low prices of all competitors, many of their sales will almost certainly be to customers who would have paid more – either because they were not comparing prices or they valued the instant transaction more.
In the B2B space, competitive intelligence is a little more difficult. There are tools available to monitor the published prices of competitors, but many B2B transactions are at lower, negotiated prices. Those negotiated prices are not available through automated searches. So a complete picture of competitor strategies needs to include how they communicate their value proposition, how their sales efforts are organized around customers, how often and in which situations you win and lose against them, and whether they tend to lead or follow the market.
We are not advocating ignoring competitor pricing or competitor activities. On the contrary, we think competitive intelligence is an important piece of the puzzle. However, strategy is fundamentally a set of choices about where your firm will compete and how it will win. Unless you are trying to win on price, which is impossible unless you have a sustainable cost advantage, there must be other components in your process of delivering value to customers. Your pricing strategy should reflect those other components of value. There are limits to how much your prices can differ from competitors, so paying attention to how your competitors compete in total and using your data to inform how your customers respond to price differences can lead to much more profitable pricing strategies.
Time and again I hear people lament that their competitors’ products are just as good as their own, and prices have to be low to win sales. The general assumption is that price is the most important factor to the customer. That assumption is usually wrong. Earlier this month there was a series of posts on Facebook that showed customers decide first on the product that meets their needs, and they are relatively loyal once they have made that decision.
Earlier in 2015 my niece began running a weekly poll of sorts among her Facebook friends. She calls it Philosophical Friday and asks a single question each week, which friends can answer however they please. Last week the question posed was, “What is the one common item that you just can’t bring yourself to buy the off-brand/cheapest option? Household items, food, clothing, shoes…whatever. The answers were mostly focused on consumer products, many of which people might consider to be commodities.
There were 39 different products mentioned, the top 10 (in terms of frequency) were:
- Cereal
- Dish Soap
- Toilet Paper
- Tampons
- All Products
- Coffee
- Mayonnaise
- Shoes
- Cheese
- Cookies
Notice the 5th item in the list – All Products. Some of the respondents said they would never buy the cheapest option for any product. Conversely only one person said they always go for the cheapest option. That person represents the one example or anecdote that you might hear in your organization about why you need lower prices. And following that advice will usually cost you money.
The Facebook survey demonstrates that customers are not homogenous, and most customers are to some degree quite loyal. Think about it in the context of your own personal and professional buying habits. How often do you price shop your favorite products, or switch providers due to lower prices? While some readers are no doubt very price sensitive, others are much less so. We all form opinions about products, brands, stores, vendors, and service providers we like. As long as the item, service or provider satisfies us, we have some tolerance for price disparity.
The implication for your business is you should not compete on price! I don’t mean you can charge anything you want, but I do mean you don’t have to beat or match your competitors’ prices all the time. Your products and services may have commodity-like characteristics, but they are not commodities. There are features and characteristics of your products and services that appeal to customers, which they value. Focus on those elements in selling to current and potential customers.
Unless you have a significant cost advantage, low prices are something all your competitors can match. If you are trying to sell based on low prices, you are not selling anything unique or differentiated. Customers consistently demonstrate that they decide what and where to buy based on how the products, services and providers meet their needs. And their primary needs are not price. So why sell on price rather than on the most important criteria?
Perhaps you are thinking, “Yes, but there is a segment of customers that is very price sensitive and I want to sell to them.” Well you are right, that segment exists. If you want to sell to them, find a way to do it without destroying the price/value relationship in the rest of your business. Come up with your own low-price brand or create a service offering with fewer high-value features. The customers who want the lowest prices will make trade-offs in features to get those lower prices. Your other customers continue to buy based on meeting their needs.
Customers make purchase decisions every day that are consistent with the Philosophical Friday poll, and price is not their most important criteria. Remember that. Don’t take the easy road and sell based on lowest price. Sell the ability of your product or service to provide real value to your customers.
Last month REI announced all 143 stores would be closed on Thanksgiving and Black Friday, REI will urge Black Friday shoppers to go outside instead. “We think that Black Friday has gotten out of hand,” said Jerry Stritzke, CEO of the chain that specializes in outdoor and fitness gear. Perhaps Stritzke can disrupt the holiday shopping season, but I doubt it. More likely REI’s posture is an effective price-communication strategy. He is really saying, “We are skipping the discount frenzy,” and he is counting on customer loyalty and low price sensitivity to maintain profitability.
For as long as I can remember (and that is too many years), Thanksgiving weekend has been the start of the holiday shopping season. Many companies have given their employees Thursday and Friday as paid holidays. Retailers, restaurants, consumer services, and public services were generally open. Those who were not required to work often found the Friday after Thanksgiving a good day to begin shopping for Christmas or whatever holiday they celebrated. Retailers responded to the increased volume of shoppers by offering discounts to compete for the traffic; and of course shoppers liked the discounts.
As discounts became the standard, retailers began to up the ante by offering exceptionally large discounts on select items for a limited period of time early in the day, aka door busters. The point of the door busters is to capture a larger share of wallet. Get customers into the store early to buy the deeply discounted items, and sell them other products with more moderate discounts. As customers responded to the door busters, stores became crowded at opening time. Some customers then responded by camping at the doors, well ahead of opening time. Retailers reacted by opening their stores earlier and earlier. First 6 am, then 5 am, then midnight. Then as online sales took off, many retailers decided to compete by opening on Thanksgiving. All of these steps have been in response to high consumer demand, and each successive step has trained customers to look for ever larger discounts.
In the case of REI, they were never a huge discounter. They compete by focusing on high-quality products at premium prices. Clearly there are segments of the population that buy outdoor gear at large sporting goods companies, department stores, and low-price stores like Walmart. However while REI’s customers would appreciate discounts, they have generally been very loyal and willing to pay more for better quality. REI has wisely protected the premium prices and margins on these customers by not chasing the more price-sensitive customers with discounts.
By publicly announcing their Black Friday closure, REI is reiterating to its customers that it will not be joining the discounting frenzy. They are also getting positive publicity from people posting the Optoutside message on social media. Ironically many of the posts I saw were from people who have shopped on Black Friday in recent years. I suspect many of REI’s employees will also shop on Black Friday now that they have the day off. They will have time to shop for a few hours and get some outside activity. And even if those posting about REI on social media avoid going to any stores on Black Friday, many of them are likely to shop online. REI will be happy to take their orders online too.
So will REI’s move become a trend? I doubt it. Pay attention to what people do, not what they say on social media. Customers will still have free time on Friday following Thanksgiving, and they will most likely still want to get started on their holiday shopping. Retailers have to compete for that business, and they have trained those customers to look for discounts. For the retailers trying to sell to price-sensitive customers, grabbing those customers early and capturing a larger share of their wallet is their best bet. Until their customers are as brand-loyal as the REI shoppers, leaving those customers to shop online or wait until the weekend would be very costly.