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WORKSHEET #21A: Price Decrease Opportunities

Step 1:

Review your random sample of 100 customers and your personal interviews of the twenty-five larger customers done in the Segmentation steps of the Basic Strategy Guide. These are steps 1 through 18. From that data, determine the percentage of customers in each Size/Role segment who offer their suppliers Last Look.

Step 2:

Interview the sales and marketing staffs to determine which Very Large and Large customers in the market, both those we serve and those we do not, do not offer Last Look. Then ask whether these customers might respond to a short-term discount offer from us to allow us to Get In the new customer relationship or to Increase Use in a current relationship.

Step 3:

If the market prices are falling or are already low, could the Company use a short-term discount with Medium and Small customers, especially the Medium customers, to improve the Company's customer mix? We obtain this answer by interviewing the sales and marketing staff using a sample of current and prospective Medium and Small Core customers.

Step 4:

It would be unusual for the Company to find many opportunities to employ excess capacity with a low price as the industry's prices are rising. However, there are special circumstances that might allow the Company to build Core relationships in this situation. If the industry is running low on capacity and the Company is a follower company, with a lower rate of capacity utilization than those of the industry leaders, consider:

  • Are there opportunities to create a new relationship, or to build an existing relationship, with potential or current Core customers by using a low price with these customers? The Company should have determined already which customers are current or potential Core customers.

  • In current or potential Near-core customers that we serve along side of the industry leaders who are running short of capacity, would these customers be potential long-term Core customers if we offered them a lower price in the short-term than the industry leaders offer?

  • Would we have any opportunities with Non-core customers to convert these customers to long-term Core status, if we used our excess capacity to support them with a below market price in the short-term?

Step 5:

Compare the average net price received by the Company on the Standard Leader product today and six months ago. If the average price today has fallen from the level of six months ago, there is a broad industry move to decrease price. The Company should consider itself in a falling price environment, a Deteriorating market.

Step 6:

Review the market share shifts of competitors in the market to identify those competitors losing market share. In order to do this, the Company would use data gathered by an industry trade association, from financial analyst reports, from the random sample of 100 customers and from personal interviews of twenty-five larger customers done in the Segmentation steps of the Basic Strategy Guide. For each competitor losing market share, determine whether the competitor's loss of share is due to a high price:

Step 7:

Compare the Company's performance in market share and growth rates of the Company's Price Leader and Next Leader products to that of the industry. You completed this analysis in Basic Strategy Guide Step 15: Evaluate the Company's Success in Penetrating Each Price Point in the Market. Consider whether the Company might create a new low Price Point by changing its benefit packages. You completed this analysis in Basic Strategy Guide Step 17: Develop a Program for New Products and Services and confirmed their value for customers. Then evaluate the Company's potential opportunities in the light of the Company's outlook for prices for the coming few years:

  • Identify performance and price changes the Company might make to create a new low Price Point.

  • Identify customer segments that might find these new low Price Points attractive. Roughly estimate the costs per unit of the major benefits the current Standard Leader product offers. Consider eliminating or reducing some of these benefits in order to reach a new lower Price Point. The lower Price Point should be at a price 25% or more below the Standard Leader product price.

  • These are the most price sensitive customers in the market. Interview sales and marketing staffs to determine who these highly price sensitive customers might be.

  • If the Company introduced one or more new low-price products, would this slow the rate of price decline in the industry? The answer to this question is yes: if the majority of new sales volume in the industry went to customers who are more highly price sensitive than is the average customer, and if these customers' basic needs would be fulfilled by the low-price product. The answer is no: if the industry has relatively high profits and competitors are showing a willingness to reduce product prices to continue their rates of growth, even at the expense of gross margins.

Step 8:

Determine whether the Company and its industry have had significant reductions in an important cost element. Compare the Company's cost per unit today for purchases, people and capital. Have any of those costs fallen by more than 5% in the past year? If so:

  • Have industry prices fallen by an amount equivalent to the cost decline?

  • If the answer is no, are industry returns above average for all industries? The data to this question is in the Tools/Benchmarks/Quartile Ranking Reports.

  • If the answer to this is yes, the Company faces exposure to new entrants.

Step 9:

Determine whether substitute products have become an increasing threat over the last year:

  • Gather the price for the main substitute product and for its Standard Leader product equivalent today and one year ago.

  • Create a ratio of the substitute product price to the Standard Leader product price, both one year ago and today.

  • If the ratio of the substitute product price to the Standard Leader product price today is smaller than it was one year ago, the substitute product has increased its threat to the industry.

  • If the substitute product has changed in a way that it reduces the customers' cost by more today than it did one year ago, it may have increased as a threat, regardless of the change in its price ratio to the Standard Leader product.

Step 10:

Determine the price discounts the Company and industry would have to offer to discourage competition:

  • Find the discount that would leave the Company's Standard Leader product price at the same level relative to substitute products as it was one year ago.

  • Determine the discount that would produce an industry median return on investment (i.e., return on net capital employed (RONCE) or return on equity (ROE) at the Company level of analysis, or return on allocated assets (ROA) at the business unit level) for all industries as shown in the Tools/Benchmark/Quartile Ranking Reports:

  • Find the reduction in the percentage earnings before interest in taxes (EBIT) that would equal the industry median RONCE. The percentage point decline in EBIT is equivalent to the price discount the Company would need to reach the all industry median RONCE.

  • Determine the discount the Company would need to reach industry median ROE by calculating the net profit that would give the Company an all industry median ROE. Subtract this net profit from the current net profit and divide the result by one minus the current tax rate to determine the reduction in revenues that would produce this change in profit after taxes. The reduction in revenues divided by the total revenues is the percentage reduction in price that would produce the all industry median ROE.

  • Determine the reduction in operating profits the business unit would need in order to reach the all industry median ROA for all business segments. The reduction in these operating profits divided by total allocated revenues produces the percentage reduction in average price the business unit would need in order to reach industry median returns on assets.

Step 11:

Determine the price levels at which each Size/Role segment becomes unattractive for the Company:

  • Determine, for each Very Large and Large customer, the price that would convert the customer from a Core customer to a Near-core customer by reducing price to the level at which the customer would just earn the cost of capital for the Company over the business cycle.

  • Determine the price at which each Core customer would become a Non-core customer by determining the price, through the business cycle, at which the customer would make exactly zero return on investment.

  • Do similar calculations for each of the Size/Role segments on the Customer Size/Supplier Role Matrix. Use average prices and costs the Company forecasts for each position on the Matrix. Then determine how much of a price reduction, through the business cycle, would create a Core, Near-core and Non-core relationship in the segment.

Step 12:

Determine the economic pay-off from any price reduction:

  • Determine the reduction in contribution margin the Company might expect from the current price reduction. Multiply the price reduction percentage times the percentage of revenues to which the price discount will apply. Assume this is the loss in contribution margin.

  • Estimate the new customer volume gained with the price reduction.

  • Estimate the current customer volume saved by the current price reduction.

  • Sum the new and saved customer volume and multiply that sales volume by the average contribution margin percentage the Company enjoys today.

  • Compare the gained and saved contribution margin calculated in the previous step to the contribution margin lost in the first step. If the former is greater than the latter, the price reduction is worthwhile.

Basic Strategy Guide Users Return to Step 21