Setting a price that is in line with competitors while also maximizing revenue is easier said than done. Pricing is one of the most important factors affecting business success and is the first thing a customer notices about an offering. It is also one of the factors customers evaluate when deciding to make a purchase (or not). With increasing competition, businesses need to keep an eye on their competitors when setting prices to get a much-needed edge in the market.
What is a Competition-Based Pricing Strategy?
Competitive pricing is a pricing strategy that consists of setting your prices based on what your competitor’s prices are. A competitive pricing analysis takes a comprehensive look at your competition to see what they are charging and why. The information you gain will help you determine where best to price your portfolio of offerings, ensuring you send the right message to customers. Competitor pricing strategies are most commonly used for offerings new to the market. When you are just starting, there may not be enough data available to understand how your offering fits with the customer base. Therefore, your competitor’s price can provide you with enough information to guide your pricing decisions. Though note that this method relies on the idea that competitors have already thoroughly worked on their pricing.
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How Is Competitive Pricing Calculated?
In order to arrive at a price, you must first group your competitors together to see where your offerings fit in the market. Generally, there are two types of competitors you need to be aware of:
- Direct Competitors: Direct competitors have offerings similar to yours and compete for the same market share. For example, McDonald’s and Burger King are both fast-food chains that serve burgers and fries.
- Indirect Competitors: Indirect competitors have offerings that are ultimately substitutable / fulfill the same functional benefit. For example, coffee and water are indirect competitors that fight for the share of throat available. In this instance, you are more competing for category share versus market share.
After a thorough analysis of your competitor’s offerings, the next step is to assess how you will price compared to them. There are three common pricing strategies to consider:
- Higher Pricing: Placing a higher price on your offerings compared to rivals is an excellent option if your products have more features, advantages, and benefits than the rest. Customers are willing to pay more for these upgrades, so ensure you do not undercharge.
- Lower Pricing: Coming in at a lower price than the competition can help you reach new customers and build market share. However, when you lower your price, the perceived value of your brand decreases, and you risk starting a price war. The only time you should price below the competition is if your offering’s features or functionality lacks compared to competitors.
- Equal Pricing: Matching prices is wise if your offering is similar to that of your competitors. Communicating the added value of your offering will be essential in persuading customers to choose you instead of the competitor.
What are the Advantages of Competitive Pricing
- Easy To Do: Competitive pricing is easy to implement as it only requires you to know who your competitors are and what they are doing with their pricing. Thus, only basic research is required. The insights will allow you to make informed decisions about your pricing to ensure you send the right message to customers.
- Lower Risk: When you evaluate your competitor’s pricing, you gain insight into the prices customers are already willing to pay. The existing standard will help ensure your prices hit closer to the mark, helping you avoid pricing too low or too high.
- Can Be Used With Other Pricing Strategies: Competitive pricing works best when used in conjunction with other pricing strategies like value-based pricing or cost-plus. Before arriving at a final price, always conduct a competitive pricing analysis to see how your prices compare to the competition and adjust as necessary.
What are the Disadvantages of Competitive Pricing
- Unsustainable In The Long-Term: A competitive pricing strategy can bring positive results when you first enter a new market. However, in the long term, competitive pricing can be a profit killer. What if your competitors base their prices on faulty data? If they are wrong, you are wrong as well. As your business evolves, so should your pricing strategy!
- Lost In The Crowd: Since competitive pricing is solely based on how your competitors behave, customers will not see you as unique. Remember that price can be used to reinforce the differentiation of your offer.
- Not Focused on Your Customer: Competitors may be going after different segments of customers than you, so it does not make sense to price after them (i.e. their customers may have different needs and price elasticities compared to yours).
- Limited Comparability: If your offerings are not comparable with what your competitors offer, following their pricing would be a mistake and could lead to lower sales volume and reduced profitability.
- Lack Of Data: In many cases, accurate competitive pricing is not available. Thus, it is always best to use competitive pricing in conjunction with other pricing strategies.
How Can You Use a Competition-Based Pricing Strategy?
Depending on the industry, competitive pricing may not be the appropriate pricing strategy to use. For example, B2B SaaS companies often offer unique feature bundles to customers. Unfortunately, without their own price intelligence, companies do not know what features to bundle and what price to set, so they either go at it blindly or make guesstimates that are way off the mark. On the flip side, B2C e-commerce companies are entirely dependent on competitive pricing because every company directly competes with at least 15-20 other companies.
It is not a question of whether to pursue a competitive pricing strategy – competition should always be a lens that you evaluate your business through. The key is understanding how to properly leverage competitive data in your pricing strategy to optimize profits versus blindly following the crowd.
If you would like Revenue Management Labs to help properly incorporate competitive analysis into your pricing strategy, reach out today!
ABOUT THE AUTHOR Michael Stanisz is a Partner at Revenue Management Labs. Revenue Management Labs help companies develop and execute practical solutions to maximize long-term revenue and profitability. Connect with Michael at [email protected]