How should a firm respond to a price cut that is initiated by a competitor? In markets characterized by high product homogeneity, the firm should search for ways to enhance its augmented product, but if it cannot find any, it will have to meet the price reduction. If the competitor raises its price in a homogeneous product market, the other firms might not match it, unless the price increase will benefit the industry as a whole. By not matching it, the leader will have to rescind the increase.
In nonhomogeneous product markets, a firm has more latitude to consider the following issues: (1) Why did the competitor change the price? Is it to steal the market, to utilize excess capacity, to meet changing cost conditions, or to lead an industrywide price change? (2) Does the competitor plan to make the price change temporary or permanent? (3) What will happen to the company's market share and profits if it does not respond? Are other companies going to respond? (4) What are the competitor's and other firms' responses likely to be to each possible reaction?
Market leaders often face aggressive price cutting by smaller competitors trying to build market share, the way Amazon.com has attacked Barnes and Noble. The brand leader can respond by:
^ Maintaining price and profit margin, believing that (1) it would lose too much profit if it reduced its price, (2) it would not lose much market share, and (3) it could regain market share when necessary. However, the risk is that the attacker may get more confident, the leader's sales force may get demoralized, and the leader can lose more share than expected. Then the leader may panic, lower price to regain share, and find that regaining market share is more difficult and costly than expected.
^ Maintaining price while adding value to its product, services, and communications. This may be less expensive than cutting price and operating at a lower margin.
^ Reducing price to match the competitor's price, because (1) its costs fall with volume, (2) it would lose market share in a price-sensitive market, and (3) it would be hard to rebuild market share once it is lost, even though this will cut short-term profits.
^ Increasing price and improving quality by introducing a new product to bracket the attacking brand.
^ Launching a low-price fighter line or creating a separate lower-price brand to combat competition. Miller Beer, for example, launched a lower-priced beer brand called Red Dog.
The best response varies with the situation. Successful firms consider the product's stage in the life cycle, its importance in the company's portfolio, the competitor's intentions and resources, the market's price and quality sensitivity, the behavior of costs with volume, and the company's alternative opportunities.
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