There’s much discussion, at the moment, across many different market sectors, about the current downward pressure on selling prices. However, many of the comments suggest a lack of understanding about the drivers behind this trend and frustration at the inability to reverse it.
So what’s going on?
Well let’s stand back for a minute and consider a few fundamentals.
We live in a free market economy, in which businesses are entitled to price their goods and services as they choose; and they bear the consequences or reap the rewards of their decisions. Whatever pricing decision you make, I, as your competitor, am entitled to exploit that decision to my advantage, if I can; and vice versa. The alternative is a command economy, which I suspect that none of us would want.
In a competitive market the price of a particular product or service varies within a range that has an upper and lower limit. To illustrate this, consider a completely hypothetical case. A particular sized bar of milk chocolate may have an average selling price of £2.50; but some brands, in some circumstances, may sell for perhaps £3.50, whilst others may sell for £1.50. No one would buy the chocolate bar if it was priced at £50; so there is an upper cut off, beyond which there is no market. Similarly, if £0.50 was all that anyone would pay, it would be below the economic cost of production so, once again, there would be no market because confectionery manufacturers wouldn’t make it. There is only a market when there is sufficient demand for a product or service, at a price that is above the economic cost of producing and supplying it.
The state of the market, at any particular time, will have an effect on the price range of the product or service involved. Back to our bar of chocolate; if demand increases but supply can’t keep up, we may well see the price range shift. The upper end of the range may increase to say £4.00 and the lower end may increase to perhaps £2.00. Alternatively, we could see the price range widen; with the lower end remaining at £1.50, while the upper end increases to, for instance, £4.00. There is also a third possibility; the upper and lower limits of the price band could remain the same, but the distribution of prices, within it, could skew towards the higher end. But, in all of these circumstances, there would be an upward momentum of one sort or another.
However, if demand continued to increase but production and output caught up and overtook it, we would have an excess of supply, creating a downward price momentum. And all the examples I gave, in the last paragraph, would then work in exactly the opposite direction.
In a declining market, the momentum on price would be downwards, if demand was falling faster than output. But, if capacity was being taken out of the market, at a faster rate than demand was falling, demand, relative to supply, would increase and the momentum on price would be upwards.
There are five things to take out of these last few paragraphs.
- Prices are distributed within a range, with upper and lower limits.
- The range itself is affected by the relationship between supply and demand, within the market. If supply exceeds demand, the price momentum is upwards; if demand exceeds supply, it is downwards.
- Upward price momentum can be driven by: –
- The whole price range shifting upwards
- The price range expanding
- The distribution of prices skewing towards the upper end
- A combination a, b & c
- Downward price momentum can be driven by: –
- The whole price range moving downwards
- The price range compressing
- The distribution of prices skewing towards the lower end
- A combination of a, b & c
- Supply can exceed demand on a rising market, if capacity is coming on stream faster than the market is growing. Demand can exceed supply on a falling market, if capacity is being taken out faster than the market is declining.
Now the moment of truth; as an individual business, you can’t affect any of this, unless you’re in a near monopoly situation, which isn’t normally the case. Applying this to today’s difficult trading conditions, anyone who thinks he or she can stop prices falling through taking tactical actions, better selling etc. is tilting at windmills. They can no more stop prices falling than they can make water flow uphill.
But that isn’t where the matter ends; it’s really where it begins, because you may be able to increase your selling prices by moving your price position closer to the upper end of the price range.
Your position, within the price range, is dependent on your competitive position, within the market. When you have significant competitive advantage over your competitors, you will be able to command a price premium over them. However, when your competitors have a significant competitive advantage over you, they will command a premium over your prices.
So what gives us competitive advantage?
Normally, it’s a combination of many factors rather than just one or two. The quality of your product, compared with that of your competitors; your standard of service, compared with theirs; your reliability; and the price you charge compared with theirs. These are perhaps some of the more obvious examples of factors that can provide competitive advantage; and let’s stick with them for the moment.
Reliability to a customer that is working to “Just in Time” procurement is likely to be a very high priority; and may mean that price is less important. But a business that maintains much higher raw material stocks may place a greater emphasis on price and be less concerned about reliability.
Component quality and tight tolerances are likely to be important to a manufacturer of specialised precision equipment; and, once again, may mean price is less important. Whereas a manufacturer of lower tech household or garden products may place more emphasis on price, providing the components he buys meet a certain basic requirement.
Service may be very important to a business looking for technical support from a supplier and he may be prepared to pay a premium to secure that service, whereas a customer who required no technical support may be looking for the lowest price.
If we continue to stick with just quality, service and reliability for the moment, markets place a weighting on these factors. Different markets will have different weightings; and weightings may differ between segments of the same market. Weightings may also change over time and there may even be a seasonality factor to consider.
From a supplier’s perspective, this means that you really do need to understand what your market wants and then make sure you provide it. If you have a production capability that can produce high quality precision components but your market doesn’t require that level of precision, you’ve got a mismatch, just the same as you would have, if your market requires technical support and you don’t provide it. In the first instance you won’t get a premium for something the market doesn’t want and in the second, if you don’t provide a service, the market does need, all you’ve got left is price.
Price, delivery, service and quality are just a few of the factors that combine to provide competitive advantage. The full list is almost endless and will be different from one market or market segment to another. So let me suggest some of the more common factors that might be instrumental in creating competitive advantage.
- Staff training – how competent, confident and effective are staff in their interface with customers? Are there formal appraisal systems and structured training programmes aimed at achieving continual improvement? Are their processes and communication channels in place that enable staff to effectively resolve customer issues and highlight problems and potential problems with management?
- Systems & process – how efficient are the back office systems in the way they interface with customers? Do customers receive the information they need, when they need it, in their preferred format; and is it accurate? Are SOP systems effectively automated?
- Distribution – to what extent do you control it and ensure that customer expectations are met? Is delivery performance measured against a range of relevant KPIs? At a time when distribution is increasingly outsourced, is there a mechanism for holding the carrier to account?
- Selling – do you have an effective sales capability? Is it well trained, properly motivated and appropriately incentivised? Does it have transparent targets, against which it is measured and rewarded? Are the targets designed to be achievable, whilst stretching individual performance? Is the sales force properly supported by the rest of the business?
- Product development – are your products right for the market? Are new products needed? Are they being developed? Should some products be dropped? Are you behind or ahead of the game? Are you at the cutting edge or a follower?
- Market intelligence – do you really know what’s going on in your market? Do you know the trends? Are you responding to them? Do you know what your competitors are doing? Are you aware of political or legislative factors that may affect the market; and are you preparing for them? Are you looking for gaps in the market and planning to exploit them?
- Brand – Do you have a strong brand? Are you supporting it in the market? Are you building and reinforcing the brand values? Are they the most appropriate brand values? Do you need to reposition the brand?
- Advertising & PR – Do you have an appropriate programme? Is it clearly defined with specific objectives? Is performance being measured? Are the objectives being met?
- Business strategy – do you have a business strategy and a business plan? Do your shareholders, directors, managers and employees all understand it and support it? Are they all focussed on achieving it? Is progress being measured? Is it working? Does it need amending or rethinking?
- Leadership – Is there board level recognition between, on the one hand, management and administration and on the other leadership? Is true leadership in daily evidence? Is leadership producing a well-motivated and fully committed workforce? Is the workforce confident in and supportive of the management of the business? Is there decisive leadership? Does the market have confidence in your leadership?
These are all factors that can and do provide competitive advantage. Their relative importance will be different, depending on the precise circumstances; but any business that wants to achieve and maintain a premium price, towards the upper end of the market price range, will need to do three things.
Firstly, it will need to be very clear about its target market. It will need to differentiate between its core market and any peripheral markets/segments that are less important to it.
Secondly, it will need to have sufficiently good market intelligence so that it can identify all of those factors, which the core target market really requires of it. Furthermore, it will need to understand the emphasis that the core target market places on each of those factors.
Thirdly it will need to deliver on each count in order to optimise its competitive position.
This challenge could range from “not too difficult” to “completely impossible”, depending on where you are now.
For those businesses, already at the top end of the price range within their particular markets, the challenge is to stay there and to remain ahead of the game. However, the further down the price range you are, the more difficult the challenge.
One of the difficulties that many businesses face today is that, up until 2008, we had 15 years of economic growth, to the extent that some people really did believe that we had broken the cycle of boom and bust. Many others, managing businesses today, have never previously done so in tough times. Real sustainable competitive advantage isn’t something that can generally be achieved overnight. Foundations have to be laid and then built on, over time. Some businesses didn’t do that in the good times and, as a result, are now exposed. Others did and remain profitable, successful and sustainable, as they take market share away from their weaker competitors, often at higher prices.
For some businesses, it’s too late; and sadly we’ve seen the casualty rate increase. But for many others it’s not too late; and, whilst there is no quick fix, they can ease their prices up, over time, by progressively creating sustainable competitive advantage. But to do this they must adopt a strategy of transformation and change; they must act with clear determination to change; and they must start now.