Effective pricing is crucial for a business. That’s the only way they would know at what price they should offer a product while maintaining a good profit margin and keeping up with the competition. A business can pick from a variety of pricing strategies and the selection depends on different factors.
A business can set a price to maximize profitability on each unit sold or on the overall market share. It can set a price to stop other market players from entering the fray, or to consolidate its position by increasing its share or simply to stay relevance.
Pricing is one of the most important components when it comes to creating marketing strategies. The price is one of the first things that a consumer notices about a product and is one of the key factors when it comes to their decision to buy it or not.
It goes without saying that the competition in the market is on a constant rise, especially with the ever rising popularity of online shopping. This means that businesses need to keep an eye on their competitors’ buying habits while setting prices in order to get the much needed competitive edge in the market. Comparing prices online is easy and customers are well aware of the monetary value of a product. These factors are also important considerations while setting the price for a product or service.
Among the various models of pricing, competitive pricing is one that has caught the fancy of many businesses. Having a monopoly is one thing—you can set the price the way you want (of course there are few government norms) but setting pricing strategies based on competitors’ behavior isn’t an easy task.
Here’s an insight into competitive pricing theory, used by most companies around the world.
What Is Competitive Pricing Strategy?
When a product is priced in accordance with what the competition is charging, it’s known as competitive pricing. It is one of the four major pricing strategies adopted by most companies. The other three include, cost-plus strategy, where a prefixed profit margin is added over the total cost of the product, demand pricing, under which the price is set by establishing the optimal relationship between volume and price, and markup pricing, where a percentage is added (as profit) over the wholesale price of the product.
When it comes to competition based pricing strategy, the purchasing behavior of customers is an important criterion. Some of the factors that companies take into account are costs, competition, and price sensitivity. In order to ensure profitable sustenance of the business, managers have to set the price such that it covers the production cost, company overheads costs, and also offers suitable profits.
In order to establish the right competitive price for your product, you need to take into account the product life cycle and the stage your product is in. Competition is one factor that you can ignore if your product is in the developmental stage. However, if it’s a part of the market, and fighting with a relatively high number of substitutes and competitors, then considering the actions of your competitors might be one factor driving your profit. You have three choices—price your product lower, higher, or same as your competitor. The most common tactic is to set the price according to the competitors, also known as the competitive pricing strategy.
As already mentioned, there are three things that you can do in order to set the right price for your products:
1. If you’re planning to set the price above the price of your competitor, then you’d need to bring in new features and improvements in your product that would justify the increased price.
2. Pricing below your competitor’s price depends on your resources. If you can increase the volume without affecting the production cost to a great extent, then this might be a good strategy for you. However, there’s the risk of diminishing profit margin and you might not be able to recover your sunk cost and even face bankruptcy. So, it’s really important that you evaluate each step of your competitor while establishing the price for your product.
3. When you set a price equivalent to your competitor, then the differentiating factors cease to exist. The focus shifts to the product itself, and if you can offer more (and better) features at the same time, it’s a win-win for you, and your competitors will fall behind.
So, competitive pricing is a game to play. Competitive pricing intelligence demands that you have in-depth knowledge of your market and target audience.
A lot of effort goes into the process of establishing a price based on competition. According to a recent survey, minor variations in prices can lower or raise profit margins by more than 20-25%. Competitive price analysis is essential to competitive pricing strategies. Let’s look at some competitive pricing examples, to get a better understanding of this process.
Competitive Pricing Examples
The concept of competitive pricing is best understood when there are only two competing parties. Suppose, two companies manufacture detergent for washing clothes. Both will charge the same price and if one company wants to compete with the other, will advertise saying why it’s the product is better.
Even big corporate giants sometimes resort to competitive pricing strategy when they want to enter a new market. They have to set the price almost equivalent to their competitor, even if the production cost is high. In case the production cost is higher, they’d have to play around and adjust the prices of packaging, advertising, and distribution.
Some companies have to use competitor based pricing, as often price is the only factor customers consider while buying a product and the switching cost for buying a product from two different stores is very low. However, in many cases like software, competitor’s behavior or data shouldn’t be the central factor for determining prices. There are numerous other variables that need to be considered in this case.
While keeping the competition factor is important while setting prices, it shouldn’t be made the central pillar.