The madness of price wars

A great post from Neil Hopkins on the excellent Interacter blog.

His opening comment brilliantly sums up a business truism that many companies consistently fail to remember.

“Opening a price battlefront is NOT the way to secure your future.  Competing on value is.”

It doesn’t matter whether this is in retail, airlines or corporate business. The maxim holds.

The last thing any company should be doing is to initiate a race to the bottom. A war in which all players may lose. That is not to say that being competitive on price is not important, and that pricing isn’t a critically important part of the marketing mix – of course it. Leading on price though is incredibly risky, perhaps the last ditch throw of a failing company. If you don’t believe me, have a look at the companies offering the biggest discounts, then count the ones that are in business in a year’s time.

Leading on price though is one of the most misunderstood strategies in business and one which is at the heart of many company failures. So lets get the reason for this stated right at start.

You do not win on price leadership – you win on cost leadership.

This is a distinction that many experienced strategists and marketers often fail to understand. Or if they do understand this, they fail to understand the logical implications of this.

In its most basic form:

  • Cost is the total sum that you incur in getting your product into the customers basket.
  • Price is what the customer pays.

From this simple definition we can logically determine some key rules:

  1. Everything that you do in your business impacts cost
  2. Reducing price without reducing cost lowers margins
  3. Reducing price below cost means that you make a loss

So, it also means that:

  • Reducing costs increases margin

    and

  • Increasing price increases margin

Of course, both lists are caveated with (assuming sales are constant), but you get the basic idea.

So how does this impact profit and performance:

  • If you want to reduce prices, you need to reduce costs if your margin is not to reduce.
  • If you reduce prices, but do not reduce costs, you need to increase sales to offset the reduced margin
  • Even if you increase sales to offset the loss in margin, your profitability is decreased as you need to increase revenue to deliver the same margin
  • Increasing sales will be possible for small increases, but larger increases will require additional investment [more stores, more flights, bigger warehouses, more people etc etc] (which again impacts your cost)

Starts to get complex doesn’t it … and this is only at the level of GCSE Business Studies.

So, reducing prices risks undermining your whole business.

I’m serious. It is that fundamental.

So faced with price competition, what should you do?

Neil’s article gives the answer here too. Win on value.

This is not simple to deliver in reality, but it is the correct answer.

How do you win on value? There are a thousands of  small possibilities – giving you  millions of combinations. What you need to do is understand which of these matters to your customer and focus on delivering these. Don’t do all of them (you cannot, but if you try then your costs will rise too high to make you unprofitable), but don’t do none (your competitors will invest, redefine service or product norms and your customers will defect).

Difficult? Absolutely. This is certainly in the hard bucket.

So where do you start?

  • Go through your whole operation and understand how each step adds value to the customer? Boring name (value chain analysis), hard work, but essential.
  • Examine whether you can do this more efficiently? Have you tested new ways of working? Can others do this better. Can you cost effectively improve it?
  • Look for opportunities to eliminate steps that are not needed, or to redesign those that are.
  • Monitor how other industries are innovating. Will these drivers affect your business?
  • Review and refine your customer listening processes? Are you listening to customers? Can they tell you what is not working and what they want to improve?
  • Know what your customers want better than the competition – then do it better.

And the most important one … START NOW.

You can avoid starting a pricing war, but you may still be dragged into one. In the current climate this is much more likely as failing business take a final throw of the dice to try and save their businesses.

Three tips to (be prepared) to survive pricing wars:

  1. Do not compete head to head in a race to the bottom if there is any other option. If a competitor business is failing, customers will notice this too. Whilst this will attract some bargain basement hunters, many customers will avoid the business. Focus on winning these customers. Sell to the values that your customers care about. Remember that price is only one of these. Instead of reducing prices, can you improve services without increasing prices [thereby increasing value]?
  2. Drive costs out of your business NOW. Don’t wait until you have to, because by then it is too late. If you have to compete on price, be able to retain workable margins and keep your business afloat. Know where you can reduce costs if you need to, even if you haven’t. Don’t underestimate the impact that reduced margins will have on your business.
  3. Remember that market leaders innovate – not just in what you can see, but what you cannot. Examine your business operations and look for efficiencies. I don’t mean getting rid of old John Smith in the warehouse – look for opportunities to work more intelligently. Even in the smallest business, examine how long tasks take and whether you can speed this up, automate it, or remove it.

 

If you see a business say that it is going to lead by reducing prices, look to see whether they have said how they will achieve this, and how they will manage reducing margins and lower profitability? If you see no sign of this, then the business is likely to be in trouble and is throwing the dice for the last time. If they have a plan built on operations efficiency, intelligent processes and innovation, then get worried, because they are not lowering pricing, they are lowering costs … and this does work.

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