Downward pressure on price

Perfect market

An efficient market where there are an infinite number of suppliers and buyers and complete price transparency.

Price transparency is one reason for downward pressure on price. The Internet also tends to drive down prices since Internet-only retailers which do not have a physical presence do not have the overhead of operating stores and a retailer distribution network. This means that online companies can offer lower prices than offline rivals. This phenomenon is marked in the banking sector where many banks have set up online companies offering better rates of interest on savings products.

A further reason for downward pressure on price is that companies looking to compete online may discount online prices. For example, easyJet discounted online prices in an effort to meet its growth objectives of online revenue contribution. Such discounts are possible since there is a lower overhead of processing a customer transaction online than for phone transactions. Note that there may be a danger in channel conflicts resulting from this approach.

Similarly, to acquire customers, online booksellers may decide to offer a discount of 50% on the top 25 best-selling books in each category, for which no profit is made, but offer a smaller discount on less popular books to give a profit margin.

Diamantopoulos and Matthews (1993) suggest there are two aspects of competition that affect an organisation's pricing. The first is the structure of the market - the greater the number of competitors and the visibility of their prices the nearer the market is to being a perfect market. The implication of a perfect market is that an organisation will be less able to control prices, but must respond to competitors' pricing strategies. It is clear that since the Internet is a global phenomenon and, as we have seen, it facilitates price transparency, it does lead to a move towards a perfect market. The second is the perceived value of the product. If a brand is differentiated in some way, it may be less subject to downward pressure on price. As well as making pricing more transparent, the Internet does lead to opportunities to differentiate in information describing products or through added-value services. Whatever the relative importance of these factors in influencing purchase decisions, it seems clear that the Internet will lead to more competition-based pricing.

Baker et al. (2000) suggest that companies should use the following three factors to assist in pricing.

1 Precision. Each product has a price-indifference band, where varying price has little or no impact on sales. Baker et al. (2000) report that these bands can be as wide as 17% for branded consumer beauty products, 10% for engineered industrial components, but less than 10% for some financial products. The authors suggest that while the cost of undertaking a survey to calculate price indifference is very expensive in the real world, it is more effective online. They give the example of Zilliant, a software supplier that, in a price discovery exercise, reduced prices on four products by 7%. While this increased volumes of three of those by 5-20%, this was not sufficient to warrant the lower prices. However, for the fourth product, sales increased by 100%. It was found that this was occurring through sales to the educational sector, so this price reduction was just introduced for customers in that sector.

2 Adaptablity. This refers simply to the fact that it is possible to respond more quickly to the demands of the marketplace with online pricing. For some product areas such as ticketing it may be possible to dynamically alter prices in line with demand. Tickets.com adjusts concert ticket prices according to demand and has been able to achieve 45% more revenue per event as a result. The authors suggest that in this case and for other sought-after items such as video games or luxury cars, the Internet can actually increase the price since there it is possible to reach more people.

3 Segmentation. This refers to pricing differently for different groups of customers. This has not traditionally been practical for B2C markets since at the point of sale, information is not known about the customer, although it is widely practised for B2B markets. One example of pricing by segments would be for a car manufacturer to vary promotional pricing, so that rather than offering every purchaser discount purchasing or cash-back, it is only offered to those for whom it is thought necessary to make the sale. A further example is where a company can identify regular customers and fill-in customers who only buy from the supplier when their needs can't be met elsewhere. In the latter case, up to 20% higher prices are levied.

What then are the options available to marketers given this downward pressure on pricing? We will start by looking at traditional methods for pricing and how they are affected by the Internet. Bickerton et al. (2000) identify a range of options that are available for setting pricing.

1 Cost-plus pricing. This involves adding on a profit margin based on production costs. As we have seen above, a reduction in this margin may be required in the Internet era.

2 Target-profit pricing. This is a more sophisticated pricing method that involves looking at the fixed and variable costs in relation to income for different sales volumes and unit prices. Using this method the breakeven amount for different combinations can be calculated. For e-commerce sales the variable selling cost, i.e the cost for each transaction, is small. This means that once breakeven is achieved each sale has a large margin. With this model differential pricing is often used in a B2B context according to the volume of goods sold. Care needs to be taken that differential prices are not evident to different customers. One company, through an error on their web site, made prices for different customers available for all to see, with disastrous results.

3 Competition-based pricing. This approach is common online. The advent of price-comparison engines such as Kelkoo (www.kelkoo.com) for B2C consumables has increased price competition and companies need to develop online pricing strategies that are flexible enough to compete in the marketplace, but are still sufficient to achieve profitability in the channel. This approach may be used for the most popular products, e.g. the Top 25 CDs, but other methods such as target-profit pricing used for other products.

4 Market-oriented pricing. Here the response to price changes by customers making up the market are considered. This is known as 'the elasticity of demand'. There are two approaches. Premium pricing (or skimming the market) involves setting a higher price than the competition to reflect the positioning of the product as a high-quality item. Penetration pricing is when a price is set below the competitors' prices to either stimulate demand or increase penetration. This approach was commonly used by dot-com companies to acquire customers. The difficulty with this approach is that if customers are price-sensitive then the low price has to be sustained - otherwise customers may change to a rival supplier. This has happened with online banks - some customers regularly move to reduce costs of overdrafts for example. Alternatively if a customer is concerned by other aspects such as service quality it may be necessary to create a large price differential in order to encourage the customer to change supplier.

Kotler (1997) suggests that in the face of price cuts from competitors in a market, a company has the following choices which can be applied to e-commerce:

(a) Maintain the price (assuming that e-commerce-derived sales are unlikely to decrease greatly with price since other factors such as customer service are equally or more important).

(b) Reduce the price (to avoid losing market share).

(c) Raise perceived quality or differentiate product further by adding-value services.

(d) Introduce new lower-priced product lines.

Forward auctions

Item purchased by highest bid made in bidding period.

Reverse auctions

Item purchased from lowest-bidding supplier in bidding period.

Offer

A commitment by a trader to sell under certain conditions.

A commitment by a trader to purchase under certain conditions.

Aggregated buying

A form of customer union where buyers collectively purchase a number of items at the same price and receive a volume discount.

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Responses

  • Peter Muller
    What is downward pressure on price?
    3 years ago
  • tiana
    What is downward pressure security market?
    9 months ago
  • emanuele
    What are downward cost pressures?
    9 days ago

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