Price formation in the phase of market compression
For the market contraction phase, a drop in demand is characteristic - partial or total. We talk about partial when it covers only certain segments of the market, about the general - when the goods cease to interest consumers (for example, the general decline in demand for amateur film cameras after the appearance of an alternative product - video cameras).
For all the similarity of processes of this kind in different markets, their influence on the prices of goods of individual firms can vary significantly. It depends first of all on how quickly and successfully this or that firm manages to get rid of excess capacities at transition of the commodity market in a phase of compression. The possibility of such price retention in the phase of market compression can be assessed on the basis of an analysis of the structure of production costs. If variable costs prevail in this structure, then the contraction of production can be carried out quickly and easily, and therefore, even in the contraction phase of the market, the firm can keep prices unchanged - with a decreasing volume of output.
A curious example of this kind will give the history of hairdressing. When in the late 1960's - early 1970's. the widespread use of electric razors and hair dryers dramatically reduced the demand for shaving and hair styling services, the prices for these services practically did not fall. The situation was balanced in another way - it's just that many hairdressers retrained and left the industry. And since it was wages that accounted for the main cost of this type of service, the withdrawal of surplus workers allowed the profitability of hairdressing salon operations to be restored without lowering tariffs.
Avoiding price reductions in the phase of market compression is possible even in the event that fixed costs make up a large part of the costs, but the basic assets themselves can easily be redeveloped to create other goods or provide other services. For example, a drop in demand for transportation to resort areas after the end of the season does not entail price wars between airlines, as they simply transfer their aircraft to other routes.
What is worse for a company is the situation if its costs are mostly permanent and irrevocable because its main assets are significantly specialized and can not be repurposed. In such industries, firms face a threat of extremely dangerous cash flow insufficiency. This situation threatens them if they fail to ensure full utilization of their production capacities.
And most often to solve this problem try just by feverish price reduction. This is prompted by the hope of intercepting the competitors' diminishing demand of still remaining buyers. However, in this phase of the product life cycle, price reduction is not necessary - and, moreover, rarely enough - generates a significant increase in demand. But it inevitably leads to a drop in the profitability of sales across the industry as a whole.
Such a reduction can be carried out only in amounts that - according to experts - are sufficient to induce weaker competitors to reduce their production capacity. Otherwise, the company faces growing costs against the background of increasing price competition, prompted by the desire of surviving market participants to capture as much of the market as possible.
In this situation, three options are possible:
• squeeze the company's assortment to the most competitive group of its products and struggle to maintain the market segment in which this group of products is sold;
• try goodbye remove the maximum "crop" profit through the establishment of prices that ensure the greatest cash inflows;
• Strengthen your position by crowding out the weakest competitors and capturing their market share.
However, when formulating price strategies for the phase of market compression, we can not talk about winning strategies over one of the competitors. We are talking about ways to minimize losses and maintain their competitive position until the time of development of goods that are in the initial phases of their life cycle.
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