If the firm in the market acted alone (as it is possible in the case of a pure monopoly), then it alone would deal with the whole curve of market demand. And then its price decisions could be based only on analyzing the sensitivity of buyers to prices and comparing their own costs for the production of goods with a price that the buyer is willing to pay for the goods with the properties attached to it. This sometimes happens to firms that produce absolutely unique products.
But usually a firm is forced to build its own policy taking into account the existence of competitors. And this fact can quite significantly modify the results obtained on the basis of accounting only the utility of the goods and the costs of its production. Even the most seemingly obvious steps, if they are taken without taking into account the tomorrow's response steps of competitors and buyers, can be very unsuccessful.
The effect of competition on the price justification process
Despite a lot of negative examples, it is not worth making an indiscriminate conclusion about the inexpediency for a firm to struggle to maintain its market share or inadmissibility to speak with an initiative to reduce prices. The main recommendation is different: taking any step in the price field, it is necessary as far as possible to comprehensively evaluate its long-term, strategic results and compare them with the benefits that can be achieved in the short term.
Therefore, the first strategic pricing rule can be formulated as follows:
You should never make a price decision just to attract another buyer or to ensure immediate sales growth. Such a decision should always obey the task of enabling the company to profitably conduct business in the long term.
Often, managers violate this rule and, having received a momentary win, in the long-term worsen the conditions of their activities. By their actions, they usually produce two types of consequences:
- Initiate a general reduction in real prices for customers (including all individual discounts);
- deprive the products of your company of the reputation of a product that deserves a premium price.
In practice, it is usually very difficult for price collectors to act in accordance with the rule given above. The reason is obvious: prices affect sales volumes faster than all other marketing tools. Therefore, when there are difficulties with marketing managers always the first motivation is to change something in prices. And to accustom them to weigh the remote strategic consequences of today's "fireman" price changes are quite difficult.
However, there is no other way out, because by its nature commercial pricing is a game that fully corresponds to the definition of this term by modern game theory: an activity whose success depends not only on individual efforts, but also on the actions of the remaining stakeholders. Indeed, no firm can unambiguously foresee the consequences of its price decisions. These consequences will be formed also under the influence of the reaction of buyers and competitors.
The matter is complicated by the fact that pricing is, more often than not, a game with a negative amount of winnings, while most managers have the skills of games with a positive amount of winnings.
Without delving into the theory of games developed by John Nash, we only recall that games with a positive sum of winning are those where the process of competition (competition) between players creates for them a benefit. And the longer such a game continues, the more (in general) the greater the gain for the players. Therefore, not only the winner but also the loser finds this game profitable: in any case, he has received something from the game and for himself. This model underlies sports and scientific activity. It is also quite adequate to describe the activities associated with the sale of goods.
For games with a negative amount of winnings, other logic is characteristic. Here participation in the game attracts costs for the players, but does not guarantee a mandatory gain. This type of games include wars, dueling, labor conflicts, etc. Here, the loser never gets any benefit for himself. Moreover, the longer such a game continues, the more likely that even a winner will find for himself, in the end, that it is not worth to enter the game. This is quite clearly traced in the field of price competition: the longer it continues and the more fierce the character carries, the more it undermines the value for competing firms of the market for which they are fighting. The reason for this is simple: the profitability of sales falls, and therefore, with a growing mass of sales in kind, the mass of profits of the opposing companies not only does not increase, but often decreases.
Price competition can turn into a game with a positive amount of winnings only under rather rare conditions, namely:
- if the demand for this product is highly elastic and the price reduction generates a sharp increase in price,
- if the increase in demand leads to such a growth in sales, that ensuring its increase in production generates a scale effect in size, allowing to compensate for the initial drop in profitability due to price reduction.
In general, price competition is best avoided. In other words, before entering the path of price competition, it is necessary to abandon the skills of sports and to force oneself to look at the alleged battle from the positions of the player who is doomed to suffer losses even in case of victory. For top managers and marketers, the logic of the field commander and staff officer is more useful, but the art of compromise inherent in diplomats. Sometimes it is formulated as "the ability to win wars without joining them". This is also quite true as a definition of the main principle of the company's competitive pricing policy, which counts on long-term profit taking in a certain market.
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