AVOIDING THE PRICE WAR MENACE - Value Insights

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AVOIDING THE PRICE WAR MENACE - Value Insights

AVOIDING THE

PRICE WAR MENACE

Part 3 of a series: Taking Action to Avoid Price Wars


Executive Summary

Oren Levy

Senior Consultant

In the previous two parts of this article series, we demonstrated

why price wars are to be avoided at all costs and suggested

the root causes for their prevalence in business today. However,

simply understanding the facts about price wars does not bring

the average organization any closer to actually preventing them.

In this third and final part, we provide guidance to managers

based on the lessons provided by some of the world’s top

organizations - those that have systematically managed to

minimize their exposure to price wars, while generating enviable

sales and profitability results year-over-year.

Avoiding the Price War Menace : Part III : Taking Action to Avoid Price Wars

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Enter the Pre-eminent Pricing

Organization

Firms such as General Electric, Johnson & Johnson and Fed Ex are commonly

among the most admired organizations in the world. These companies

consistently outperform their competitors, deliver valuable products and services

to the market and provide secure and long-term returns to their investors. It

should also come as no surprise that these same organizations rarely engage in

price wars.

Despite differences across industries, customer demands and competitive

dynamics, Pre-eminent Pricing Organizations (PPOs) have been able to

safeguard their revenues and profits from price wars because they share one

unique feature. They have all undergone a fundamental shift in attitude regarding

the importance placed on pricing management – raising it from an occasional

activity to a strategic imperative to the long-term success of the company.

Clearly, this mentality shift would not have been possible without the undying

support of senior management and the tenacity of employees at all levels

to modify their behaviour over a long, sustained period in pursuit of the

singular vision of improving top and bottom line performance. Although highly

challenging to emulate, all companies can take steps today to improve their

pricing management and become “price war proof”.

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Trait #1: PPOs Invest in Raising their

Pricing Prowess

PPOs understand that few managers are innately blessed with the skills to

manage pricing strategically, and thus make pricing education a formal process

within the organization. Often enlisting the help of outside pricing experts or

seasoned pricing personnel, PPOs arm their decision makers with the tools,

information and confidence to make better pricing decisions and continually

update and upgrade their training initiatives to reflect changes in personnel and

knowledge requirements over time. Considering that so few of their competitors

actually invest in pricing training as they do, PPOs enjoy an added competitive

advantage, which serves only to further solidify their market leadership position.

Recognizing that incorporating such a process

requires time, commitment and resources, a great

way for organizations to train their managers

to avoid price wars in a relatively low risk

environment is through a simulation. Simulations

are a powerfully convincing tool when it comes to

demonstrating the negative impact of price wars

and stimulating dialogue among decision makers

to develop more creative approaches to market

pressures other than price discounting.

Avoiding the Price War Menace : Part III : Taking Action to Avoid Price Wars

3M is able to maintain its

premium pricing strategy

and avoid price wars

by training each of its

brand managers using

an internally developed

“Strategic Value Pricing”

course

One client, upon learning that a new competitor was set to launch a low-priced

product in the market, undertook a simulation to assess the impact of lowering

its price to defend its market share. In each scenario tested, the client found

that dropping their price ultimately resulted in a price war. This difficult finding

forced the client’s managers to focus on the fact that customers’ expectations

of support services were very high in the industry. Therefore, instead of

lowering price, the firm actually invested in enhancing its customer service and

delivery offerings to its current customers and was able to minimize defection

and maintain profitability as a result. After the decision was executed, it was

estimated that the simulation saved the organization over $500M in revenue that

would have been lost in a price war.

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Trait #2: PPOs Give Pricing it’s Due

Respect

Another trait shared by PPOs is that they legitimize pricing within their

organization by elevating it to the status of a function – much like sales,

marketing, finance or operations. By endowing their pricing functions with the

authority and accountability to develop and execute their pricing strategies,

PPOs have been able to achieve consistent sales and profit growth, and in turn,

avoid price wars.

One firm that has benefited tremendously from their pricing function is General

Electric. Due to the vast number of unique businesses within the GE portfolio,

the company has assigned each business unit with a pricing manager, who

is responsible for supporting the group with pricing strategies and tactics as

appropriate to their goals and objectives. In turn, each pricing manager reports

to the Chief Pricing Officer, who is directly responsible to the CEO and who

is charged with coordinating best pricing practices across all of the firm’s

businesses on a global basis. Through this feedback mechanism, GE is able to

optimize its revenue and profitability and reinforce its market position over time,

all while staying clear of price wars.

One of the main challenges faced by all organizations when attempting

to establish a pricing function is in recruiting and retaining talented and

experienced personnel for the job. Pricing savvy managers are a rare breed with

unique skill sets that require them to balance the often-competing demands

of several functions within the organization at once in order to make effective

decisions. Ultimately, companies that openly endorse the pricing function’s

relevance to the firm’s top and bottom line performance are most successful in

attracting these individuals.

For most firms however, it is premature to establish a pricing function, as

attitude shifts are first necessary to legitimize pricing management within the

organization. A useful first step is to form a pricing committee, comprised of

top-level personnel from sales, marketing, finance and operations, to collectively

guide the firm’s pricing strategies. A pricing committee is an excellent proxy for

a true pricing function because it brings in one room, all of the interests that a

pricing manager would have to consider in order to make effective decisions.

Furthermore, the process of convening, in and of itself, may actually reduce the

threat of price wars by mitigating the possibility of emotional reactions.

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Trait #3: PPOs Avoid the “Commodity

Mindset” by focusing on Customer Value

PPOs have also kept clear of price wars because they avoid the “commodity

mindset”, despite selling product or services, which are commonly perceived

as commodities in the marketplace. The starkest difference between PPOs

and their less successful competitors is that they focus not on selling their

customers an incremental unit of their product or service, but instead on

providing their customers with a value-based solution to their unmet needs. The

concept of “solution-based” selling is not new, in fact companies have used it

for several decades. Where PPOs differ however, is in the execution. PPOs have

successfully re-positioned themselves as “business partners”, because they are

able to direct their customer’s attention towards delivered value and away from

transactional price.

During 2001, Cisco Systems found themselves in a “commoditized” situation.

Not only did it appear as if they sold virtually the same Network Hardware

and support services as their competitors, but customer IT budgets were

being slashed, driving most of their sales discussions to price negotiations. To

combat these challenges, managers at Cisco realized that they would need

to change their transactional sales mentality by focusing the sales process

around customer value. Under the mantra “diagnose before you prescribe”, the

value-based selling initiative began with an in-depth discussion with customers

regarding their key objectives and areas of concern in meeting those objectives.

Once customer needs were clearly understood, Cisco was able to match the

appropriate services and map deliverables directly to each of the customers’

challenges and goals. They next sought to quantify the benefits associated with

the solution in terms of ROI that the customer could agree to and communicated

the financial impact of their value back to the customer during the sales closing

stages. By the end of the pilot study, Cisco earned a 100% close rate on all

projects proposed using the value selling process, while significantly reducing

price discounting to win the business. Since then, Cisco has been able to enjoy

sales growth and avoid the threat of price wars despite aggressive competitive

pricing.

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Trait #4: PPOs Reward Employees

on Profit and Not Merely Volume

PPOs recognize that market-share driven pricing decisions are typically at odds

with profit driven pricing decisions. By striking an appropriate compromise

between the two and by adopting compensation systems that support the

desired mix of profitability and market share goals, PPOs have been able to alter

their front-line employees’ pricing behaviour to avoid decisions that cause price

wars.

Consider the case of a $200M electronic components manufacturer. The

company’s President received an unsettling report from the VP of Sales

indicating that on average, the sales force was discounting the company’s key

component product line by 10%. In some cases, sales representatives were

even offering discounts as high as 25%. Through the Marketing department,

the President obtained research suggesting that customers perceived their

components as providing the most value of all competitive products. Armed

with this information, the President believed that his sales representatives, who

were rewarded on unit sales and rather than profit, were unnecessarily overdiscounting

in order to win business and improve their commissions.

In response, the President revamped the compensation system to reward

the sales team based on meeting volume goals while maintaining an average

discount of 5%. Although, latitude was given to discount up to 20% for

particularly price sensitive customers, the President noticed immediately that the

initiative was significantly reducing revenue lost through discounting. By yearend,

the President was able to reverse a trend that was eating away at revenue

and profit, while leading his company away from the price war path.

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Trait #5: PPOs Invest in Info-Intensive

Systems, Supporting Effective Pricing

Considering that many price wars result from misread signals, insufficient facts

or poorly considered consequences, market information is the ultimate form of

“power” when it comes to reducing the risk. As such, PPOs continually invest

in developing and improving data rich systems, which integrate cost, customer

and competitive information into an easily accessible and updatable format that

supports more informed decision-making.

Take the case of a packaged goods manufacturer, which, despite being the

category leader, was constantly responding to the aggressive price discounts

offered by its nearest competitor. To brainstorm ideas as to how to strategically

respond to this competitive threat, the company formed a multi-functional pricing

committee around the product line. During the committee’s deliberations, several

options were generated however it was clear that there was insufficient customer

and competitive pricing information to adequately test the outcomes of the ideas

they had generated. The committee undertook dynamic pricing research and

found that the entire category was highly price insensitive and that their product

line did not lose significant market share, even despite their chief rival’s deepest

discounts. The committee realized that instead of responding to the competitor

with discounts that might set off a price war, it should instead raise prices

to generate greater profits. The category leader raised prices and witnessed

little decline in volume. Furthermore, profitability climbed and ultimately, the

competitor stopped resorting to discounts much to the benefit of the entire

category.

As the above example would indicate, most organizations need not invest

large sums to build an effective information system, since many of the data

components required often already reside within the company or is inexpensively

gathered through external research or internal analysis. Typically, it is the

integration of the various cost, customer and competitor databases developed in

isolation that prevents firms from benefiting from an effective pricing information

system. For that reason, successful organizations have tended to have a pricing

function or committee already in place prior to investing in assembling a pricing

information system.

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What To Do When Under Attack

by an Aggressive Competitor

When it comes to price wars, an ounce of prevention is better than a pound of cure

and organizations that attempt to emulate the traits of PPOs, go far in “price war”

proofing their company. Of course, despite best efforts to avoid them, managers

may still feel threatened by price wars, especially by aggressive competitors who

may not be as aware of the consequences. In such cases, organizations may wish

to utilize some of the following defensive tactics to stave off the threat.

1. Before making any response, always ask these key questions:

• What are the key motivators behind our competitor’s decision to drop price? Are their

challenges internal or do all competitors face them?

• What does the competitor hope to accomplish by dropping price?

• What is the nature of the price decrease (e.g. pure price discount, reduction in discount

percentage, volume discount, etc.)? What does it really “mean” to the market?

• How desperate is the competitor? What will be their upside/downside?

• How will the customer interpret this move?

• How will this impact our business and the industry long term?

By considering these questions, managers gain a clear understanding of the threat

presented to them, while taking time to pause for thought immediately after a threat

has been unveiled to allow dangerous emotions to subside. In this way managers

can collaborate within their organization to come up with creative responses that

do not involve sparking or perpetuating the price war.

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What To Do When Under Attack

by an Aggressive Competitor...cont

2. Attempt to avert the competitor by commenting on pricing in the press

By commenting on an aggressive market leader’s pricing tactics in the business

press, senior managers can relay “signals” back to competitors without collusion,

that may motivate them to retreat from their stance. An excellent illustration of this

takes us back to the “Burger Battle” described in Part I of the series. Although

McDonald’s announced it was evaluating the merits of an aggressive pricing

strategy, Burger King might have been able to avert the war through some evasive

action. Imagine if, instead of immediately responding with a Value Meal of its own

to trump McDonald’s, Burger King’s CEO made the following remark in the press.

“This is a very competitive category and we are all facing challenges, but any

competitor who wishes to price aggressively should know that we will never let

them “buy” market share that easily and would be forced to match their every

tactic. “

Such a comment would have sent a clear message back to McDonald’s senior

managers that any gains they might have hoped to achieve through discounting

their menu would have been met with resistance. Perhaps this might have forced

McDonald’s to at least reconsider its “Value Menu” strategy and seek alternative

courses of action. Sadly, Burger King’s desire to beat the competition led the

industry down another path and hindsight is always 20/20.

3. If all else fails, show your competitor they cannot win with price by

matching their move tit-for-tat

There are occasions, when despite making all the “right” moves, a company is

unable to avert a price war. In those instances, there is often little recourse left

other than to show the competitor that any aggressive price move made will be

immediately matched. When organizations faced with this challenge unwaveringly

match their aggressive competitors forays each and every time, the aggressors

quickly learn that any attempts to win business with price discounting will fail and

that they should desist from future price discounts.

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Conclusion

It is true that price wars are a reality in today’s business environment. Yet, with

a deliberate vision and commitment, most organization can take steps today to

minimize their exposure to the ill effects of price wars. These tactics are not for

the feigned of heart, or those who seek a quick fix, however, sticking to these

initiatives will more than pay off over time in the form of more secure revenue

and profitability. Good Luck!

Oren Levy has been a pricing strategy consultant for over 6 years. Prior to that he held

roles in sales, marketing and market research. Oren currently heads up Value Insights Inc.

and throughout his career has helped numerous clients improve their top and bottom line

performance through more effective pricing management. Oren can be contacted directly at

(416)-924-0904 or olevy@value-insights.com

Avoiding the Price War Menace : Part III : Taking Action to Avoid Price Wars

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For more information, please contact us:

phone : 416 924-0904

email : info@value-insights.com

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