Price leader or price follower? Each has its merits.

Price leader or price follower? Each has its merits.

by Michael Hurwich President of SPMG

If the terms ‘cut-throat’, ‘bitter rivalry’, and ‘open warfare’ describe the state of price competition in your industry it is more than likely that several competitors are challenging each other for the role of industry price leader.

The problem, of course, is that in most industries market share competition is a negative-sum game. There can be only one leader, and until that leader is firmly established, price instability and continual downward pressure on industry margins will persist.

For organizations that optimize their role as leaders or followers, profitability can be dramatically improved by understanding the differences between the two stances.

As the name implies, price leadership involves establishing price discipline in the marketplace while followship means optimizing position behind the price leaders.

While the leadership role may sound like a highly desirable position for any firm to occupy, the fact is that attaining price leadership is expensive, and will only be successful if the leader has a perceived superiority for its products or services in the minds of industry buyers.

Perceived superiority can come from many sources, such as a unique brand image, technological advantage, or high levels of customer service.

Regardless of how it is achieved, perceived superiority creates brand loyalty and lowers the price sensitivity of buyers and this is a foundation of price leadership.

In most but not all industries, the price leader is also the market share leader. For example, Procter & Gamble holds both these leadership positions in many of the markets and categories in which it competes.

Note, however, that market share leadership is not necessarily a prerequisite for price leadership. In fact, in some industries, perceived superiority may require a perception of exclusivity, which is incompatible with a high market share.

Leadership strategies

Successful price leaders employ three key devices to protect their leadership status. Firstly, leaders can exercise their clout over industry buyers to raise the industry price ceiling. In raising the ceiling, the price leader can rely on brand loyalty to minimize customer fall-off. Nevertheless, the leader must be prepared to “bite the bullet” and refuse to budge in the wake of protests from buyers, even at the risk of losing a sale.

The second lever at the price leader’s disposal is the ability to demonstrate discipline to competitors who attempt to undercut them in the marketplace. The key here is to ensure that the demonstration is sufficient to convince the errant firm that challenging the leader does not pay.

Not surprisingly, in order to be effective, the demonstration of leadership can also be expensive. The cost to the price leader of temporarily reducing the price of a leading brand over the disciplinary period can exceed fifty percent of the contribution margin.

The final tool available to the price leader is the communication to the industry at large of the commitment to remain in the role of price leader.

Typically, successful price leaders clearly communicate their intention to retaliate vigorously against any competitor who refuses to follow their lead. One of the most effective methods of communicating this commitment is to establish a pattern of consistent behavior, since past behavior is normally used by competitors as an indicator of future actions.

While price leadership may not entirely define the battleground upon which the competition will be fought, it does identify one weapon that is off limits – price.

Price leadership also implies that the price leader will not use price in response to non-price threats to the leader‘s market share. For example, a price leader will not use price to respond to a competitive line extension or to a successful advertising campaign.

A “tit-for-tat” approach is usually established whereby competitive initiatives are met by appropriately related responses.

An alternative approach

Price leadership, if executed properly, can improve long-term profitability, but as stated before, leadership is expensive to achieve and maintain. Clearly, the strengths required to be the price leader are not always available to every company.

For some, a much more profitable alternative is to pursue a price followship strategy.

Where price leadership entails establishing price discipline, price followship involves a willingness to operate within the established boundaries.

The term “followship” may be repellent to those companies with an intensely competitive spirit and a sales-driven culture. Be assured, however, that price followship is not a “roll over and play dead” strategy. Rather, effective price followship involves an intelligent, disciplined commitment to maximize profitability.

·        The successful price follower is guided by these principles:

·        Match but do not undercut the pricing set by the price leader.

·        Refrain from using tactics that encourage the leader to respond with price.

·        Follow and openly support the leader‘s price increases.

·        Ensure that your pricing strategy is clearly understood by the leader and other competitors.

It is interesting to note that although price leadership and price followship are two very different strategies, the most effective action in executing both strategies is to establish a pattern of consistent behavior.

In the case of the price follower, consistent behavior would involve establishing a track record of such moves as matching but never undercutting the leader‘s prices, and never pursuing one of the leader‘s key customers through price.

It would be naïve to think that a company wishing to make the transition from a would-be price leader to a price follower would be able to do so overnight. It is likely that in the short-term other competitors, especially the price leader, will not trust the firm to behave like a follower, particularly if there is a history of bitter competition in the industry.

Moreover, from an organizational culture perspective, the shift to price followship can be a difficult strategy change, particularly in organizations that are traditionally sales-driven.

The payoff, however, of becoming a successful price follower can be enormous. After all, there can only be one price leader in any industry–and only a handful of companies have the resources and the abilities to be the leader.

For other firms, focusing on increased profitability by being a successful price follower surely makes more sense than continually provoking the price leader with vain attempts to overtake it.