Far too often, we meet clients that set their prices using their competitors’ prices as a base. Let me first underscore that this approach is not always wrong - there are, indeed, markets that are so mature and saturated that your competitors’ prices will be backed up by a sufficient amount of data and experience to ensure accuracy. But for the majority of businesses, this is not the case.
Breaking Down “Competitor-Based Pricing”
It’s a pricing strategy where you set your prices using your competitors’ (or the “market”) prices as a base and then add a premium that reflects how you think your product’s value exceeds or falls short of the base product. If you’re selling chocolate chip cookies with 5 chocolate chips in them whereas your competitor’s only has 4, you add a small premium to your price that will reflect the marginal value of an additional chocolate chip - this premium is typically value-based (and that’s great!), but the base price is not reflective of your customer’s value perception.
Here are 3 reasons you should think twice before using a competitor-based pricing strategy.
1. Your Competitors Are Wrong
Studies have found that just 8-15% of all businesses use best-practice pricing strategies; that is, value-based pricing methods that set prices on basis of the customer’s willingness-to-pay. If you manage to find a company selling a product identical to your own using a value-based pricing strategy - that’s great! But this is unlikely.
Bottom line is that your competitors’ prices are probably incorrect, or not applicable to your product as most products have, at least slightly, different attributes. Thus, by pegging your price to theirs you will end up setting your own price inaccurately. This will result in sub-par sales and unrealized profits.
2. You Don’t Know Who Your Competitors Are
No matter who your customers are, their money will be scarce, and ultimately they face a trade-off between your product and an alternative. If you’re selling $2 bags of cookies, this alternative could be the cookies of a rival cookie brand - but it could also be a Coke, a can of Pringles or even a bus ticket. It would be impossible to compare your prices against all the alternatives your customer is considering, both because there are so many and because these alternatives differ between each customer. By pegging your price to your direct competitors, you completely disregard the broad competition for your product and you may be in for an unpleasant surprise.
3. Price Wars Are Costly
Competition-based pricing is also known as strategic pricing. Whenever your competitor changes its price you react with a similar price adjustment. In other words, you’re behaving strategically and counteracting the effect of your competitor’s adjustment. Consequently, your competitor will start anticipating this move and take it into account when adjusting prices. You’re effectively stealing a chunk of their sales and so your competitor will lower its prices to get it back. Pursuing your competitor-based pricing strategy, you lower your prices accordingly and your competitor then lowers its prices again - and so on, and so on. Ultimately, this will get you an almost non-existing profit-margin or even losses if your competitor has lower costs than you.
Final Note: Big Companies Are Not Perfect
If you’re selling a product that is fairly similar to that of a big, market leading company, it might be tempting to use a competitor-based pricing strategy; surely, such a big company has its pricing right? Wrong! Big companies are, of course, market leaders for a reason, but it is certainly not always for their pricing strategy. We talk from experience here; don’t automatically assume they’re doing it right just because of their size.
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