WHY PRICE CUTS DON’T BUILD SHARE

by Donald V. Potter

Customers often say they buy on price. The real buying process is more complicated.

Buyers actually choose suppliers via a hierarchy of decisions on function, reliability, convenience, and price, in that order. Price is not their first consideration. It is their last.

The Story of a Roof

A man who re-roofed his home says that he made the decision on price. A bit of probing revealed a different story.

• What type of roof did he buy? He wanted shake (his function choice, which eliminated all suppliers who supply only other types of roofing).

• How did he choose the roofer? On the recommendation of a neighbor (which satisfied his concerns about reliability and convenience).

• Had he shopped around for price? No — this roofer had made an acceptable bid.

In fact, price was not the basis of the buying decision. If the roofer believed he won on price, he would be mistaken.

Few Buys are Based on Price

“In the vast majority of purchases, price is not a factor.”

Few customers really buy on price. Like the man buying the roof, a customer proceeds through the buying hierarchy, moving on to the next stage only when two or more suppliers meet his needs at the present stage. As long as a customer has the choice of suppliers, he can become ever more discriminating. In the vast majority of purchases, price is not a factor because one supplier meets a more important need.

A customer buys on price only when all other considerations are absolutely equal for him. If, for example, a buyer wants a TV with certain features, a warranty, and delivery within a day, and if two stores meet those criteria but one offers the TV for $25 less, the buyer can choose on price. That is, until the second store matches the lower price.

Low Prices Cannot Buy Market Share

“Price discounts move little share because competitors match them.”

In hostile markets, competitors often try to keep or gain share by cutting price. This seldom works, for three reasons:

• Only a subset of potential customers will ever reach the stage of considering price.. A company that cuts price can hope to gain share only from that subset gaining, in effect, a minor fraction of all potential buyers.

• Prices are easily matched. As our TV example illustrates, a price advantage is ephemeral. When two offerings are otherwise equal, one supplier can simply match the other’s price and the competition for a sale continues. In fact, once hostility has been underway for three to four years, price discounts move little or no share because all competitors match them.

• Price sensitive customers are the least desirable. In any market, some buyers will be “price shavers.” They, too, consider function, reliability, and convenience, but with such broad requirements that many suppliers meet their minimum needs. Then they shop for a few cents off. They build no relationships with suppliers, and the share they contribute can disappear in an instant.

In Hostile Markets, Price Defensively

Suppliers cannot ignore price. In a hostile market, competitors’ price cuts should be matched, to avoid the “Leader’s Trap”. The trap is that, by ignoring price cuts made by competitors (especially new entrants), a supplier may give competitors a toehold, even if with only the unreliable “price shavers.” This inroad, however tenuous, may allow the competitor to grow, and eventually to offer function, reliability, and convenience that would appeal more broadly to the market. Matching price cuts is a way to keep new competitors at bay and avoid the loss of any share that might move on price.

Price cutting should be defensive, however. A supplier should always remember that the more secure basis for market share is to offer a unique advantage further up the buying hierarchy on function, reliability, and convenience.

Closing Thought

Once hostility is well underway, price discounting does not move share. It does destroy profitability, though. Price discounting will last throughout hostility and will not end until all discounters conclude that price discounts are futile. Then, hostility ends.

(Note: This Perspective was written in the context of the economy in 1992. While some of the companies may have changed their policies or indeed no longer exist, the patterns they exhibit still hold today.)

Recommended Reading

For a greater overall perspective on this subject, we recommend the following related items: Analyses: Analysis 18: Positive Volatility by Position Analysis 20: Win and Fail Definitions Analysis 24: Competitive Vulnerability Analysis 48: Average Price Received by Competitor Analysis 49: Market Segments Where Share Moves on Low Price Symptoms and Implications: Symptoms developing in the market that would suggest the need for this analysis. The industry is seeing its first price wars Foreign competitors are expanding with low prices Customers are more price sensitive Most competitors are offering low prices after a period where leaders held prices high As large competitors match low prices, other competitors face difficulties Large competitors are maintaining price levels as smaller competitors discount