Pricing In A Downturn

One economic law that holds true is that relating to supply and demand. If demand is greater than supply, the price goes up, and if less, the price goes down. So what are the actions that businesses must consider when pricing in a downturn?

No matter how the market you operate in is classified, there will be a market price for the product. Not just one price, mind you, but a band of prices. Some companies may be able to charge a premium over the market price; others will sell below it. Some products are more sensitive to price than others. It depends on the customer's perception.

Most consumers, for example, do not differentiate between brands of 91-octane ULP petrol. In contrast, many consumers differentiate between brands of beer. Thus, the greater the perceived product differentiation, the wider the band of market prices. Furthermore, price occupies a less prominent position in the decision-making process.

Factors that dictate the width of the price band

Price is less important if product/service is:

More highly differentiated
Customer knowledge of market pricing is limited
Risk of non-performance is high
Not a significant percentage of customer's total costs
One-off purchase
Discretionary

Price is more important if product/service is:

Low differentiation
Customer knowledge of market pricing is comprehensive
Risks associated with poor performance are low
Significant percentage of customer's total costs
On-going purchase
Essential

In any market, the market price band will move over time in response to market forces, over which the individual supplier has no control. When the movement is upwards, those at the upper limit of the market band will seek to maintain or even increase the premium that they charge. Those that operate at the bottom of the price band will increase their prices marginally, but hope to improve their market share. Thus not only will the band move upward but also increase in width.

Pricing in a market where demand exceeds supply is a lot easier than pricing in a downturn - particularly for those that sell at the upper end of the market price band. They may have to make, not one, but two adjustments. Both are downwards.

The first of these is to align their prices to the new lower market price band. For example, the median market price has fallen from $100.00 to $90.00. Our supplier has been selling at $110.00 or a 10% premium that its customers have been willing to pay. Our supplier has no option but to reduce its price to $100.00. However, in percentage terms, the premium over the new median price has risen from 10% to 11% and if the downturn in demand is really marked, the supplier may find that it needs to reduce its premium as well (the second adjustment).

Pricing in a downturn

Products with narrow price bands are more susceptible to such movements
You cannot sell above the upper limit of a price band
When market forces move the price band downwards, it narrows even further
Under these circumstances, those companies that operate at the lowest extremity of the price band suffer most
Products and services are now available from the premium suppliers at very competitive prices

The reality is that premiums tend to erode over time and the market price band decreases in width.

A universal pricing formula

We suggest using the following universal pricing formula:

P (Price the customer is prepared to pay) </= COPV (Customer's own perceived value at time of purchase)

The COPV must be equal to or less than the Price. If this equation is out of equilibrium, then either one reduces the price or one increases the COPV to compensate.

Every business would like to leave the price as is and raise the COPV, but if the reason for the equation being out of equilibrium is a fall in the market price, the premium supplier has no option but to follow suit. However, the premium supplier will doubtless attempt to maintain this premium, in percentage terms if not in dollars.

So what are the actions that suppliers must consider when pricing in a downturn?

Have in place a process to constantly monitor competitive price levels
Accept that you cannot sell at a price above the market price band that exists at any point in time
Focus equally on "Quality of Product" and "Quality of Service". The arena for product differentiation is shifting from Quality of Product - increasingly regarded as a given - to Quality of Service. Resist the temptation to reduce service levels along with the price
Maintain standards. If you fully meet your customers' expectations, they will be reluctant to seek out other suppliers, and will also continue to pay your premium
Negotiate longer periods of supply to offset lower prices
Instead of one price that incorporates all aspects of your offer, offer a tiered pricing system that reflects additional levels of product and service
Consider price/volume discounts
Focus your customer's evaluation of your offer on the total cost of ownership as justification for your price premium
Examine every aspect of your operations to see where productivity can be improved or costs can be reduced - but not at the expense of Quality of Product or Quality of Service
Look at other growth strategies

In summary

If you sell at the median price or below, you will be regarded as "just another supplier" and will forever compete on the basis of price
No company can ignore a fall in the market price band brought about by over supply or reduced demand - you have to face reality
Do your utmost to maintain your differentiation to protect your premium. Remember that if a reduction in the median price hurts you, it will hurt the "price sellers" even more
Think strategically about pricing. This means focusing on the external influences on pricing, not on your internal costs

bpi consultants and its principal Graham Haines, provide businesses with management and strategic marketing advice using the feedback from their range of proprietary surveys. The feedback from their customer feedback surveys has played a large part in their understanding of "Pricing In A Downturn". Visit our website www.bpisurveys.com.au or contact us on +61 3 9870 5159 or ghaines@bpisurveys.com.au
First published: 26 June 2008.
Last updated: 26 June 2008.