Price Ladders in Emerging Markets: 4 ‘Steps’ to Higher Margins
In general, price sensitivity is higher in emerging markets, and the general willingness to pay is lower. That being said, firms often overestimate how price conscious consumers are in emerging markets, and underestimate the spending power of up-scale consumer segments. While prestige is a driving force in all markets, segments with a high willingness to pay in developing countries show a particular emphasis on cachet, and have a strong preference for Western, state-of-the-art brands that have traditionally been in limited supply in these markets. In many cases, if you wish to target these consumers (which many firms do), then you don’t want your product to become ubiquitous.
Therefore, it is also a misconception that prices should, by default, be much lower in emerging markets. Sure, there are some very price conscious consumers -- often not worth targeting -- but there are also these aforementioned cachet-driven consumers that happily pay a premium to own a trendy, Western product. In fact, the price conscious consumers often won’t care very much about your brand, which leaves you with little competitive advantage over local firms that almost always win the price war.
Of course, you want to accommodate the lower income level and willingness to pay, but don’t leave money on the table from those high-WtP consumers. When firms serve a wide spectrum of customers in developed countries, they tend to address this problem by using a so-called price ladder.
Definition: A ‘price ladder’ is a product strategy that involves supplying several product versions at different quality- and price points. The term ‘ladder’ is used to describe the strategic purpose that is initially drawing customers with the lowest quality/price combination, and the subsequently make them interested in higher quality versions, which are also more expensive -- thus encouraging them to ‘climb up the ladder’.
The typical price ladder in developed markets has three steps, typically a ‘good’, a ‘better’, and a ‘best’ version. For example, a firm selling hot tubs will have a stripped version that makes the customer consider the brand: the price looks appealing, but at the same time, it’s obvious that the product only possesses core features. Now the firm has got the customer’s attention, and the customer will start looking at the ‘better’-version, where additional, advanced features are available at a modestly higher price. If the customer is price conscious, she’ll probably stick with this version, and not consider the ‘best’-version. She’s interested in value for money, and doesn’t care about buying ‘the best’ if it means paying a lot extra.
But then there’s the cachet-driven consumer with a high willingness to pay and low price sensitivity. She can still be value-conscious, and initially attracted by the low-priced ‘good’-version, but in order to get the most advanced features, highest quality and most modern design, she will be willing to pay a substantially higher price for the ‘best’-version.
In emerging markets, however, firms may add an additional step to their price ladder. They got a new lower bound of incredibly price conscious customers who will pick a local brand any time if the price is lower, even if the Western product is better. To convince these customers to take the risk of making the first purchase, the fourth step of the ladder is needed, which typically is referred to as the ‘fair’-version. Contrary to the ‘good’-step in the developed-market-model, the aim of the ‘fair’-step isn’t to provide a favourable anchor for the better version. It’s really to provide great value at a great price to those who otherwise wouldn’t buy the product.
In fact, Harvard’s emerging markets experts Vijay Govindarajan found that the requirements for the ‘fair’-version are incredibly high. While the target group for this product has a low spending power, they also cannot afford to replace the product too often, and for some product categories such as tools and equipment, the product must be durable under quite tough conditions. Therefore, referring to this step as the ‘fair’-version may be misleading.
Ultimately, however, it is important to remember that it is, indeed, possible to make ‘fair’-buyers climb the ladder. The risk of trying new brands in emerging markets are quite high, and you will find that brand-loyalty is driven by reliability quite extensively. Therefore, launching a ‘fair’-version that is too low in quality can be detrimental.