Price Changes

After developing their pricing structures and strategies, companies often face situations in which they must initiate price changes or respond to price changes by competitors.

Initiating Price Changes

In some cases, the company may find it desirable to initiate either a price cut or a price ­increase. In both cases, it must anticipate possible buyer and competitor reactions.

Initiating Price Cuts

Several situations may lead a firm to consider cutting its price. One such circumstance is excess capacity. Another is falling demand in the face of strong price competition or a weakened economy. In such cases, the firm may aggressively cut prices to boost sales and market share. But as the airline, fast-food, automobile, retailing, and other industries have learned in recent years, cutting prices in an industry loaded with excess capacity may lead to price wars as competitors try to hold on to market share.

A company may also cut prices in a drive to dominate the market through lower costs. Either the company starts with lower costs than its competitors, or it cuts prices in the hope of gaining market share that will further cut costs through larger volume. For example, computer and electronics maker Lenovo uses an aggressive low-cost, low-price strategy to increase its share of the PC market in developing countries. Similarly, Chinese low-price phone maker Xiaomi has now become China’s smartphone market leader, and the low-cost producer is making rapid inroads into India and other emerging markets.17

Initiating Price Increases

A successful price increase can greatly improve profits. For example, if the company’s profit margin is 3 percent of sales, a 1 percent price increase will boost profits by 33 percent if sales volume is unaffected. A major factor in price increases is cost inflation. Rising costs squeeze profit margins and lead companies to pass cost increases along to customers. Another factor leading to price increases is over-demand: When a company cannot supply all that its customers need, it may raise its prices, ration products to customers, or both—consider today’s worldwide oil and gas industry.

When raising prices, the company must avoid being perceived as a price gouger. A blue circle icon. For example, when gasoline prices rise rapidly, angry customers often accuse the ­major oil companies of enriching themselves at the expense of consumers. Customers have long memories, and they will eventually turn away from companies or even whole industries that they perceive as charging excessive prices. In the extreme, claims of price gouging may even bring about increased government regulation.

A photo shows a signboard at the entrance to a gas station. The sign shows a red arrow with the text “24 7.” In between the two numbers, there is an illustration of a gas station.

A blue circle icon. Initiating price increases: When gasoline prices rise rapidly, angry consumers often accuse the major oil companies of enriching themselves by gouging customers.

© Jerry and Marcy Monkman/EcoPhotography.com/Alamy

There are some techniques for avoiding these problems. One is to maintain a sense of fairness surrounding any price increase. Price increases should be supported by company communications telling customers why prices are being raised.

Wherever possible, the company should consider ways to meet higher costs or demand without raising prices. For example, it might consider more cost-effective ways to produce or distribute its products. It can “unbundle” its market offering, removing features, packaging, or services and separately pricing elements that were formerly part of the offer. Or it can shrink the product or substitute less-expensive ingredients instead of raising the price. P&G recently did this with Tide by holding price while shrinking 100-ounce containers to 92 ounces and 50-ounce containers to 46 ounces, creating a more than 8 percent price increase per ounce without changing package prices. Similarly, Kimberly-Clark raised Kleenex prices by “desheeting”—­reducing the number of sheets of toilet paper or facial tissues in each package. And a regular Snickers bar now weighs 1.86 ounces, down from 2.07 ounces in the past, effectively increasing prices by 11 percent.18

Buyer Reactions to Price Changes

Customers do not always interpret price changes in a straightforward way. A price ­increase, which would normally lower sales, may have some positive meanings for buyers. For example, what would you think if Rolex raised the price of its latest watch model? On the one hand, you might think that the watch is even more exclusive or better made. On the other hand, you might think that Rolex is simply being greedy by charging what the traffic will bear.

Similarly, consumers may view a price cut in several ways. For example, what would you think if Rolex were to suddenly cut its prices? You might think that you are getting a better deal on an exclusive product. More likely, however, you’d think that quality had been reduced, and the brand’s luxury image might be tarnished. A brand’s price and image are often closely linked. A price change, especially a drop in price, can adversely affect how consumers view the brand.

Competitor Reactions to Price Changes

A firm considering a price change must worry about the reactions of its competitors as well as those of its customers. Competitors are most likely to react when the number of firms involved is small, when the product is uniform, and when the buyers are well informed about products and prices.

How can the firm anticipate the likely reactions of its competitors? The problem is complex because, like the customer, the competitor can interpret a company price cut in many ways. It might think the company is trying to grab a larger market share or that it’s doing poorly and trying to boost its sales. Or it might think that the company wants the whole industry to cut prices to increase total demand.

The company must assess each competitor’s likely reaction. If all competitors behave alike, this amounts to analyzing only a typical competitor. In contrast, if the competitors do not behave alike—perhaps because of differences in size, market shares, or policies—then separate analyses are necessary. However, if some competitors will match the price change, there is good reason to expect that the rest will also match it.

Responding to Price Changes

Here we reverse the question and ask how a firm should respond to a price change by a competitor. The firm needs to consider several issues: Why did the competitor change the price? Is the price change temporary or permanent? What will happen to the company’s market share and profits if it does not respond? Are other competitors going to respond? Besides these issues, the company must also consider its own situation and strategy and possible customer reactions to price changes.

A green circle icon. Figure 11.1 shows the ways a company might assess and respond to a competitor’s price cut. Suppose a company learns that a competitor has cut its price and decides that this price cut is likely to harm its sales and profits. It might simply decide to hold its current price and profit margin. The company might believe that it will not lose too much market share or that it would lose too much profit if it reduced its own price. Or it might decide that it should wait and respond when it has more information on the effects of the competitor’s price change. However, waiting too long to act might let the competitor get stronger and more confident as its sales increase.

A green circle icon. Figure 11.1

Responding to Competitor Price Changes

Flowchart explains responding to Competitor Price Changes.

If the company decides that effective action can and should be taken, it might make any of four responses. First, it could reduce its price to match the competitor’s price. It may decide that the market is price sensitive and that it would lose too much market share to the lower-priced competitor. However, cutting the price will reduce the company’s profits in the short run. Some companies might also reduce their product quality, services, and marketing communications to retain profit margins, but this will ultimately hurt long-run market share. The company should try to maintain its quality as it cuts prices.

Alternatively, the company might maintain its price but raise the perceived value of its offer. It could improve its communications, stressing the relative value of its product over that of the lower-price competitor. The firm may find it cheaper to maintain price and spend money to improve its perceived value than to cut price and operate at a lower margin. Or the company might improve quality and increase price, moving its brand into a higher price–value position. The higher quality creates greater customer value, which justifies the higher price. In turn, the higher price preserves the company’s higher margins.

A photo shows a sign outside a Starbucks outlet. The sign reads “Seattle's Best Coffee - Bold Flavor. Smooth Taste.”

Photo shows a sign outside a Starbucks outlet. The sign reads "Seattle's Best Coffee - Bold Flavor. Smooth Taste." Fighter brands: Starbucks has positioned its Seattle’s Best Coffee unit to compete more directly with the “mass-premium” brands sold by Dunkin’ Donuts, McDonald’s, and other lower-priced competitors.

© Curved Light USA / Alamy

Finally, the company might launch a low-pricefighter brand”—adding a lower-price item to the line or creating a separate lower-price brand. This is necessary if the particular market segment being lost is price sensitive and will not respond to arguments of higher quality. A blue circle icon. Starbucks did this when it acquired Seattle’s Best Coffee, a brand positioned with working-class, “approachable-premium” appeal compared to the more professional, full-premium appeal of the main Starbucks brand. Seattle’s Best coffee is generally cheaper than the parent Starbucks brand. As such, at retail, it competes more directly with Dunkin’ Donuts, McDonald’s, and other mass-premium brands through its franchise outlets and through partnerships with Subway, Burger King, Delta, AMC theaters, Royal Caribbean cruise lines, and others. On supermarket shelves, it competes with store brands and other mass-premium coffees such as Folgers Gourmet Selections and Millstone.

To counter store brands and other low-price entrants in a tighter economy, P&G turned a number of its brands into fighter brands. Luvs disposable diapers give parents “premium leakage protection for less than pricier brands.” And P&G offers popular budget-priced ­basic versions of several of its major brands. For example, Charmin Basic “holds up at a great everyday price,” and Puffs Basic gives you “Everyday softness. Everyday value.” Tide Simply Clean & Fresh is about 35 percent cheaper than regular Tide detergent—it’s “tough on odors and easy on your wallet.” However, companies must use caution when introducing fighter brands, as such brands can tarnish the image of the main brand. In addition, although they may attract budget buyers away from lower-priced rivals, they can also take business away from the firm’s higher-margin brands.

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