In a dynamic business world, price administration cannot end with the setting of an initial price. Changing marketplace conditions often require the organization to cut or increase prices to stop making changes.
Companies often face situations where they may need to reduce or increase their prices even after developing pricing strategies and structures.
In this post, we will discuss how a company initiate price changes and reacts to price changes. Let’s learn about the circumstances leading a firm to cut or increase the price; how customers, competitors, distributors, suppliers, and government react to price changes; and how to respond to competitors’ price changes.
Initiation of Price Changes
For making price changes, a company can (1) cut/lower the price or (2) increase the price. Let’s try to understand them.
Initiating Price Cuts
Tradition holds that any competitor can lead prices down, but only dominant competitors can lead prices up. Prices may be cut temporarily either to introduce a new product or to sell excess inventory.
If a company’s market share is declining, the marketing executive can decide to cut the price to revive sales.
A small competitor may institute price cuts to gain market share; however, a large competitor will follow price reductions only if a greater amount of profit will be lost by not doing so.
Price reduction or cut occasionally occurs even in oligopoly. The reason is that no mechanism can control all of the companies operating in the marketplace.
In the product’s growth stage, the marketing executive may cut the price on an incremental basis because competition becomes greater, and the supply of competing items grows.
The executive may also wish to tap a larger share of the target market – those who can not pay the higher price.
To successfully compete during the maturity stage, the marketing executive will significantly cut the price since competition peaks. The target market becomes an extremely price-sensitive group at this stage.
Price cut may also be initiated to achieve more widespread distribution of the product or special promotional efforts or move out excess inventory.
A company, then, cuts price under several circumstances of which excess plant capacity, declining market share, and drive to dominate the market through lower costs are important.
Initiating Price Increases
You know that changing marketplace conditions often require the organization to increase prices. You should note that only dominant competitors can lead prices up. This rule of thumb holds some of the time.
Only companies with relatively large market shares are likely to be successful in leading price increases. One of the most frequent causes of initiating price increases is a change (rise) in the cost of producing or selling the item.
The impetus for a price change, thus, first comes from increased costs. Price increases may also be initiated, anticipating increased future labor costs, basic supplies, and many fixed expenses.
The decision to initiate price increases is also influenced by the general sensitivity of demand to price and competitors’ possible reactions. A move to a higher level of price may reflect product superiority for a firm with a highly differentiated product.
Of course, such upward moves are easier to sustain when non-price promotional efforts have created a strong selective demand for the product. With the increase in costs, a marketing executive may decide to increase prices rather than maintain it.
Overdemand is another variable that may motivate the marketing executive to initiate a price increase. There may be a situation when a firm may not meet all who desire the product.
To discourage a certain segment of buyers to cope with the overdemand situation, the firm may initiate the price increase.
Many circumstances may lead a firm to increase its price, of which cost inflation, general sensitivity of demand to price, and overdemand are notable.
A company can also deal with the above two situations without raising prices. One of the following techniques may be adopted by a company to face cost inflation and overdemand without price increase:
- It may shrink the amount of product.
- Less expensive materials and ingredients may be used.
- It may reduce or remove some of the product features.
- It may also remove or reduce product services such as warranty, free delivery, and free installation.
- Less expensive packaging materials may be used, or larger sized package may be promoted.
- The number of sizes and models may be reduced.
- New economy brands may be developed.
Reactions To Price Changes
A company’s product’s price may affect many parties such as customers, competitors, suppliers, distributors, and government. We shall now discuss the reactions of different parties to a price change in the following sections:
Reactions of Customers
Customers may react differently to price cuts, such as the item may be abandoned; it is faulty or not selling well; the firm may quit from this business; its quality has been reduced, or price may come down further.
Customers may equally react to the price increase of an item.
The price increase, though, normally reduces sales, may carry some positive meaning as well. Customers may consider the item as “hot” and may rush to buy it, anticipating that it may not be available in the future, or they may consider the item worth even if the price is raised.
Customers are normally price-sensitive to costly items or items frequently bought compared to less costly and less frequently bought items.
Reactions of Competitors
Marketing executives must have a clear idea of the competitive environment in which they operate to estimate the extent of pricing flexibility available.
Like the customers, competitors also react to the price change of a company’s product. This reaction is inevitable if there are few competitors if buyers are highly informed, and if the product is homogeneous.
Like customers and competitors, the distributors, suppliers, and government may also react to a company’s price changes.
Distributors may find it less profitable dealing with a product the price of which is raised, or they may find it less prestigious selling a product whose price is cut. The suppliers may ask for a higher price if the product’s price is increased.
Besides knowing about customers’, competitors,’ distributors’, and suppliers’ reactions, one needs to recognize the legal restraints that limit freedom of pricing action.
Responding to Competitors’ Price Changes
Following price changes is usually less risky than leading. If a dominant firm increases its prices, smaller competitors can hold steady and hope to gain market share.
If they follow the leader’s increases, they are likely to hold their current shares at least. They may even improve their profits with little risk.
What if relative market shares are fairly even among several competitors? In this case, the firm that leads to price increases takes the greatest risk. Customers obviously favor price cuts, but they have to be educated about increases.
It is, therefore, always safer to follow, but this is not always an option. A firm’s survival may hinge on leading with a price increase at the right moment.
In the case of homogeneous products, a company can either cut its price as soon as the competitors cut their prices, or it may augment the product to compete.
If the competitors increase the price in a homogeneous product, a company can match its price accordingly if it thinks that price increase will benefit the industry.
In non-homogeneous products, a company can react to competitors’ prices in many ways, such as maintaining price, raising perceived quality, reducing price, increasing the price and improving quality, and launching a low-price fighter line.
Competitors’ pricing actions are sometimes impossible to predict, but they can have devastating effects.
Marketers face difficult pricing decisions and must make them quickly. What the marketing executive should exactly do depends on the situation.
Like so much else in marketing, price administration is only part of science; much depends on intuition, preparedness, and art.