Initiating and Responding To Price Changes
Internal or external forces often lead an organization to change its prices. Price changes are often initiated by the organization. The organization also has to design its strategy to deal with price changes initiated by competitors.
INITIATING PRICE CHANGES
An organization may initiate price changes to deal with new forces arising within the organization or the market. The price change may occur at both directions: increasing price or lowering prices.
(i) Increasing Price
Increasing price of a product is an attractive proposition for every business organization, since a small increase in the price results in huge increase in the revenue and profits. If an organization feels that the sales volume will not be affected by a small price increase, it may always be tempted to increase the price.
Most price rise are the results of inflation that causes the organization’s costs to increase. Costs often increase when the government introduces new taxes or raises the current tax rates. Increase in the price of any factors of production – wage levels, raw materials prices and interest rates – cause the price to increase. Often, organizations anticipate such increases and may raise the price of its products in advance.
Sometimes, an organization may increase the price in order to reduce the demand for the product. When an organization cannot increase the supply of its over demanded product, it may raise the price level to manage the demand at the current supply point.
(ii) Lowering Price
Several situations lead an organization to reduce the price of its products. Organizations with excess capacity try for extra sales in order to achieve higher capacity utilization rates. In such a situation, it may find lowering price the most easy method of achieving higher sales volume.
Some organizations often lower the price to achieve higher sales volume, and thereby capture larger market share. These organizations believe that once they are to dominate the market and hold to a large market share, the resulting sales volume may allow it to achieve economies of scale.
Lowering price is very risky strategy. It usually invites sharp reactions from competitors and often results into a price war. Care less prices cuts may lead an organization into the following traps:
- Low quality trap: An organization initiating price cuts may fall in a low quality trap when consumers associate the new low prices to a poorer quality product.
- Fragile market trap: It may fall into a fragile market trap when price sensitive consumers wait for further price cuts or search for cheaper products.
- Shallow pocket trap: It may fall into the shallow pocket trap if financially strong organizations react by huge price cuts to counter the price cuts initiated by a weak organization.
RESPONDING TO PRICE CHANGES
An organization faces a strategic decision situation when competitors initiate price changes. Responding to the price change, particularly in the case of price cuts is a difficult question. The organization has to consider the objective and time frame of the price change. The following clues are important in responding to price changes:
If the price cut has been initiated in order to use excess capacity or to cover rising costs, it does not warrant any response.
- If the price change is temporary or short term, initiated to clear old stocks, there is no need for response.
- If the objective is to dominate the market and the price change is long term, the organization has to respond quickly and effectively.
- The organization should also evaluate the consequences of non response to the price change.
- If the price change does not seriously affect it current sales and market share, there is no need for response.
- Before showing any response, it should carefully watch how other competitors react to the price change.
Responding to a competitor’s price change is also influenced by the status of the organization in the market. Small follower firms are forced to follow the price changes initiated by a large organization that forced to follow the price changes initiated by a large organization that performs the role of the price leader. The price leader normally establishes the market price that is adopted by several price follower firms.
Sometimes, the price leader is also troubled by smaller firms through severe price cuts. In such a situation, the price leader has the options of response or non response. The leader organization may not respond if it does not expect to lose any significant portion of its market share.
If the price cut is expected to seriously hurt the market share and profit situation, the leader organization may take one or more of the strategic options:
Option 1: Increase customers perceived value of the product by increasing promotional level.
Option 2: Increase the price complemented by an improvement in quality and features of the product. This requires a re-positioning strategy to establish the brand at a higher price position.
Option 3: Add a new lower price brand to the current product line and position it directly with the attacker’s brand. This trading down strategy helps the organization to maintain high quality image for the old brand.
Option 4: As a last option, reduce the price to off set the negative effects of the price attack.