Did you know, on average, a 1% price increase translates into an 8.7% increase in operating profits?

It's hard to believe the smallest percent increase or decrease in price can make a significant impact on profit margins. This statistic highlights the importance pricing can have on your company's bottom line.

Now, I'm sure you're wondering which pricing strategies will help you turn a profit. Should you charge the going rate for your industry? Or should you choose pricing that's well above the market price?

It's worth considering competition-based pricing.

This dynamic strategy allows businesses to use competitor prices as benchmarks when finding a price for their product. Since competitors enter and exit the market, and the market fluctuates, businesses have the ability to proactively adjust their prices.

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Competition-based pricing is also known as competitor-based pricing or a competitive pricing strategy. It's often used by businesses that sell similar products.

For example, retail companies often use this method because prospective customers often evaluate the switching cost between each competitor (e.g., lower cost versus higher quality), and the products are relatively similar in design and function.

Businesses have three options for pricing their product with a competitor-based pricing strategy:

  • Price below competitor prices
  • Price match competitor prices
  • Price above competitor prices

If companies choose to set their prices lower than competitors, they'll be a low-cost leader in the market. Salespeople can communicate their products' value and attract prospects to the low price. Before decreasing their prices, businesses often lower production and overhead costs to make sure their profit margin doesn't shrink too much.

When a business matches the price of the competition, they need to set themselves apart from the competition. This is often done through creative marketing and branding techniques that help create a unique value proposition.

A company that chooses to set its price above competitor prices has to justify the premium price. This can be done by offering more features, additional benefits (e.g., expert customer service), or creating higher quality product than competitors.

With a competitive pricing strategy, you'll stay on top of the competition and make your pricing dynamic compared to other competitors in the market.

Advantages of Competition-Based Pricing

Think a competitive pricing strategy will work for your business? It's always a good idea to weigh the benefits and costs of a pricing strategy before making a final decision.

Below are some of the primary advantages of pursuing a competition-based pricing strategy.

1. Prices are dynamic.

Since you're basing the price of your product based on competitor benchmarks, prices can change as your business grows and develops. Competitive pricing analysis will keep you informed so you can compete with market leaders. And price tracking software can help you automate this analysis.

2. It's simple to execute.

With a relatively simple analysis of your competitors and their prices, you can determine your selling price without any complicated formulas or calculations. Whether there are two competitors in the market or 200, you'll still be able to evaluate their prices to set your own.

3. It can be combined with other pricing strategies.

Competition-based pricing focuses solely on the competition, ignoring consumer demand and production costs. It's often in a business' best interest to use more than one pricing strategy to take these additional factors into account.

For example, a SaaS company can look at the cost to develop and market its software, and use the cost-plus method to determine its selling price. Before settling on a final price, they can see where it places them in comparison to similar competitors in the market. With a pricing model that combines both strategies, they'll be able to stay ahead of the competition and cover their costs.

Disadvantages of Competition-Based Pricing

This pricing method won't be beneficial for all businesses. Here are a few of the disadvantages of competition-based pricing.

1. It ignores consumer demand.

Competition-based pricing assumes that competitors are pricing their products intelligently and that other players in the market should follow suit. This pricing strategy works well if a few businesses in the market use it.

But if a large portion of the market uses a competition-based pricing strategy, the market will eventually lose touch with consumer demand. This is because prices either remain stagnant from following the lead of a primary competitor, or companies change their prices on a whim based on competitors pursuing the same competitive pricing strategy.

2. It's easy to become passive.

Since it's so simple to base prices solely on the competition, businesses risk becoming complacent in their price setting. They might ignore other signs (e.g., a drop in profit margin or a change in consumer demand) that indicate they should adjust their pricing strategy.

3. It's not ideal for small retailers.

Oftentimes, smaller retailers have limited funds, which can make a competition-based pricing strategy challenging. If they price their product too low, this could cut into their profit margins and hurt the business.

And if they set the price too high, they might not have the financial means to outdo their competitors and live up to the price (e.g., lack of capital, resources, employees).

Here are a few competition-based pricing examples that demonstrate how this pricing strategy is often implemented.

1. Price below competitor prices

A grocery store chain has its own line of cereal. It analyzes the prices of the brand name cereals and prices its own cereal below the average price of the competition. They'll hope to make more sales based on the assumption that consumers will choose their low-cost product over the pricier cereal options.

2. Price match competitor prices

There's a gas station on one street corner who has its standard gas priced at $3.18. You look across the street and see a different gas station offering gas at the same price. Both gas stations sell a similar product, and the force of the market has resulted in each business selecting the same price.

3. Price above competitor prices

Let's say a computer company is trying to determine a price for its laptop. It looks at the competition and decides it can make the most profit by selecting a price that's above competitor prices.

How does the company attract customers to a higher price point? It sets itself apart from the competition by offering a premium product with a sleek design and additional features. Since the competitors don't offer these perks, consumers will be more likely to pick the premium laptop.

With competition-based pricing, you'll be able to keep up with the Joneses (aka your competitors). As with any pricing strategy, you'll want to evaluate its advantages and disadvantages. But, with the proper planning, a competitive strategy can be a valuable addition to your pricing model.

Want to learn more about pricing strategies? Check out this guide to cost-plus pricing next.

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Originally published Mar 29, 2019 11:02:05 AM, updated September 05 2019

Topics:

Pricing Strategy