In the UK hospitality industry today, there is a price war going on, ‘what’s new?’ you may cry, and yes whilst there are many smaller skirmishes in the market as there always has been and always will be, this is something bigger. The price of bottle coolers is reducing on an almost monthly basis and this spiral towards the bottom is showing no signs of slowing down. With the rise of the far eastern manufacturers developing their facilities and tooling and the growth of online business, it seems almost anybody with a laptop and a bit of online know how these days is able to set up as a supplier, and there are manufacturers from all over the world beating a path to their doors to supply them.
Whilst this spirit of free enterprise is to be encouraged, particularly in the current economic climate, there is an environment developing for the big to get bigger and the not so big to disappear altogether. From the small independent taking a punt on a truck load, to the large wholesalers like ourselves with several factory lines globally, nobody can avoid being affected by the current climate and rash of seemingly ‘new’ lines at bottomed out prices being introduced to the UK market year on year.
The most common cause of price wars is someone trying to increase market share, which usually means taking a share from your competitors. The fastest way to do that is by lowering your prices. You reduce your price, more people choose your cooler over those of your competitors, and presto, your market share goes up.
The standard reaction to this is your competitors will lower their prices in response. No company is going to stand idly by and let you take their share. Now both companies have the same market share as before, only at lower prices. Certainly it wasn’t worth it.
The company introducing the original reduction may do this repeatedly (after all, the business wants to grow market share) until it finally realizes it will not “win” a price war. By then, the damage is usually done, nobody ‘wins’ a price war, they just survive it if they’re lucky
In terms of assessing your margins and scalability on the cost side, straight discounts are the first step on the road to ruin, not only in terms of finances but also in people costs. In a discount environment, you are essentially setting your team up to work more for less money.
Let’s say you’re selling a unit for £100 a unit, and your net cost is £70. Your net profit on each unit sold would be £30. If you sold 10 units at full price, your net profit would be £300.
Now let’s say you decide to have a sale with a 10% discount offer. After selling 10 units at £90, you have revenue of £900. The net cost for units remains constant at £70, but your net profit has decreased to £200.
That doesn’t seem too bad. Until we realize we need to sell 50% more units just to keep our profit margin even, at £300.
15 units X £90 =
£1350 - £1050 =
As the discount to the customer gets better, the bottom line gets worse. At a 15% discount, we’d have to sell 100% more units (a total of 20 units) to keep our profits at £300:
20 units X £85 =
£1700 - £1400 =
How stressful must it be to work for or run a company where the pressure is on day-to-day to sell 100% more units just to stay even?
Essentially, you’d be turning up for work every day to put yourself out of business!
Customers become sensitive to price at the expense of value and benefits. If you are a provider of a quality product, you probably tend to charge a higher price than competitors. Customers buy your product because they perceive that the benefits it offers more than outweighs the price premium they must pay. As long as customers focus on the benefits side of the equation, superior suppliers can sustain the premium.
Alas, as price wars play out, suppliers bombard their customers with price rather than benefit messages and this tends to upset this price/value balance. The inevitable result is that customers become more and more price sensitive and less and less value sensitive. This is, for example, now happening in other industries such as the mobile/tablet market. Despite a steady stream of quantum performance improvements, evidence is growing that demand may collapse as soon as prices stop falling at their current dramatic rate. Worse, even when such a war is over, the price/value see-saw does not automatically tip back the way it was before. Here, too, price wars change customers—usually adversely, often forever.
This leads to customers having their expectations distorted. Customers’ perceptions of acceptable prices are harmed long after price wars end. For example, in the 1994 Pentland Wholesale catalogue the RRP for a Whirlpool K20 icemaker was £765 and it became the UK’s best selling ice machine, in the most recent 2011 catalogue, the price is £769, so although some may say we have a legitimate argument to suggest that we should be costing it at more than £4 extra after nearly 20 years, customers now have it etched in their minds that £769 is the correct and acceptable price for that unit, and any attempt to increase it would be met with robust opposition and customers would be unlikely to buy it again until the cost returned to that level, as we proved a couple of years ago when we did attempt to bring it in line with the cost increases, but the perception of that unit’s value has been permanently altered.
These developments are consistent with current research on price psychology and price recall. This work shows that the lowest price someone pays for a product or service is remembered longest, and remains his or her reference point for a very long time—often for life. Maybe that’s why grandfathers remember what they paid for their first Ford Cortina or first home. The point, of course, is that the low prices accompanying price wars influence a customer’s perception of what is a “reasonable” price long after the war ends.
We could never say you should never discount, we as a competing company don’t have that objectivity, but you should certainly always look to add value, both real and perceived. That could mean including a delivery or installation service, an extended warranty or a free annual check up for example, or it could mean a better customer service experience. People are more willing to pay for good service these days than ever before.
The reality for any business is that you won’t ever be able to cut your way to success, as a major wholesaler we have as much of a duty to our customers as we do to ourselves and you can cut costs only so far before some aspect of the business suffers. Growth is really the only option. The answer may lie in something as basic as thinking of ways you can leverage your current resources in new or innovative ways. Reposition products or services, for example, with a private label at a higher price point.
What does all this mean for today’s independent retailer, who must deal with the threat of price wars daily? On researching this piece I came across an interesting, albeit bleak, perspective of someone directly involved in major pricing wars. “You know,” he said, “price wars are like heart disease.” Heart disease is serious, and it can kill you. We all are at risk. Some of us have higher inherited risk than others, just as some industries have an inherently higher risk of price wars than others. Still, however great the risk, you can affect your risk of heart disease by the way you behave every day: by your diet, whether you smoke or not, how much you exercise, and so on.
In much the same way, your day to day pricing behaviour will affect your risk of a price war. You increase it with every competitive misread, with every market misread, with every over-reaction, with every failure to charge an adequate premium for your superior benefits. Prevention is the best cure.
Each and every pricing action needs to be passed through a price war screen
It’s at this point I’d like to offer a snippet by Robert A Garda who suggest that the current management notion “to win the business that is best for you at the highest possible price” seemed wise in the past. But an amendment is in order: the right managerial objective should be “to win the business that is best for you at the highest possible price consistent with behaviour that minimizes the risk of price war.” Each and every pricing action needs to be passed through a price war screen. Managers need constantly to ask themselves, ‘Will this action contribute to the creation or extension of a price war in my industry?’ If the answer is Yes or even Maybe don’t do it.
Ultimately, it will be a string of seemingly insignificant but correct day-to-day pricing actions that provides the firewall to keep your company from suffering the ravages of a price war. Building that wall and keeping it strong is a disciplined is an endless struggle—but a struggle well worth confronting and winning
Whatever you do, think twice about the ramifications of running a 10% off sale, unless you got a really great deal from your manufacturer. Just remember that ‘small’ 10% discount means someone in your organization has to work 50% harder to earn the company the same margin. And in most cases for our customers, that person will most likely be you.
Don’t fall into the trap of thinking if you don’t give discounts, you’ll lose
sales. Look to add value and deliver an incredible experience for your customers. You’ll discover new ways to increase profits, while others find themselves caught in the discount trap — and soon out of business.
‘The value of something is remembered long after the cost has been forgotten’ – Warren Buffett