Given the importance of price in driving consumer decision-making firms often have a strong inclination to lower their prices. Hence, price wars are extremely common.

Fighting the urge

After all drop in price will almost always increase sales, but I would encourage you to fight this urge because there are several dangers associated with competing on price. One danger of low price is inciting a price war and the amazing thing about a price war is that people are always convinced that it’s the other guys fault.

In fact one survey found that among firms that reported being in a price war fully 88% believed it was the competition’s fault. That’s right, almost 90% of come companies insist it was the other guy that started the price war. The truth is nevertheless that it simply takes somebody to take your price and go 5% lower to start a price war.

Fighting myths

There is a common belief among  MBA students about dropping price, they tend to believe that there exists some magic price point that’s low enough that they’ll attract customers, but not so low that the competition will react to it. Let me be very clear that price does not exist.

If lowering your price is driving customers from your competitor to you, your competitor will react and often the easiest fastest least risky way for them to respond is to simply lower their price to match your drop and now we got a price war.

Your competition will always be more sensitive to your price changes then will be your customers. If your competitive strategy involves lowering your prices be sure that you anticipate how your competitors might react and if you find yourself thinking they are too smart to start a price war with us that would be bad for them too.

Winning a price war

The only way to win a price war is if you have the lowest cost structure in your competitive set. If you do you can sustain lower costs over the long haul. So if you are the Walmart of your industry, if you have super lean operations and the most efficient logistics then, by all means, pursue a low price strategy.

But, if you don’t have significant cost advantages than trying to win on price is a losing proposition. Try differentiating your product or focusing on branding or changing upper distribution, but don’t compete on price unless you have an advantage on cost.

Targeting for price advantage

One of the justifications for lowering prices is to attract new customers, this is the second danger of low prices, if you must lower your prices to attract customers you’re probably failing somewhere else in your marketing. Usually it means you haven’t done your targeting and positioning correctly.

Essentially when you lower your prices to attract customers you are paying customers to buy your product, you are buying customers who are not your target customers and these customers will overwhelmingly be disloyal customers. Think of this sad lesson of Groupon and other large discount coupon and companies.

Many companies jumped at the chance to get these new customers through their doors to try their offerings, but companies change their tunes relatively quickly. They discovered that these coupon customers came in use their discounts and then they would leave and never come back and why should they?!

Basically there are only two types of companies for which it makes sense to use a group on type service one is companies who have margins that are so high they can still turn a profit when they sell it half off, which is great work if you can get it.

The other case is if you’re offering is so clearly obviously massively superior to anything else that just trying at once will convince customers that they should come back later regardless of the price. So basically if you’re selling heroin this works as a business model. If you’re selling sandwiches not so much.

Low price inferences

The last danger of pricing low is the quality inferences customers make based on price. The fact that people tend to associate lower-priced options with lower quality is well known, but not many marketers realized just how powerful this tendency can be. Studies prove that the link between price and perceived quality can be very powerful.

The final thing to understand about prices is that customers are often not nearly as well-informed about prices as many marketers assume they are. When asked right after placing something in their cart fewer than half of of the shoppers surveyed were able to report and even somewhat accurate guess as to the price of what they had just chosen.

Some people have interpreted these results to mean that price doesn’t matter, that consumers don’t pay attention to or don’t care about price. Prices clearly matter, but I think we do have some reason to question the assumption that consumers are always well-informed about prices, that consumers always have accurate up-to-date reference prices that they can draw on to make comparisons and evaluations.

Context-based price comparisons

There are two alternative paths customers have for evaluating prices and one is to compare the prices of readily available items. This is known as using external reference prices or as using the local decision context to evaluate prices
and let me note a couple of basic principles for managing context-based price comparisons.

First marketers need to be aware of the general principle of extremist aversion. For this reason firms often offer products at the highest or lowest points they know are unlikely to sell well. By having those very high or very low offerings available they are making the remaining products seem more moderately priced thereby increasing the sales of those offerings.

The second basic principle for managing a context base price comparison is that people tend to use the context to gauge their reference prices relative to other people. it turns out that people often are too focused on whatever prices they happened to see at the moment and are insensitive to whether that set of prices reflects all of the prices on the market.

Price image

When consumers don’t have a well-defined reference price for a particular product they will just assume that a price of encounter is consistent with the retailers price image. Why does this matter to marketers? The answer is simple: a stores price image should be managed like a brand image.

In other words price images are not formed based just on the store’s objective prices rather consumers also use lots of non-price cues when forming a price image including the stores decor, it’s location, the level of service provided the quality of its merchandise and so on.

Price images are best managed not just by managing prices but by managing all the price related associations consumers my form with the brand.

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