Price leadership occurs when a leading business within its sector or industry is able to determine the price of what they sell. That decision forces others in the industry to match their pricing scheme to hold onto their own market share. It occurs most often within a sector where the goods and services have little differentiation between the leader and the rival.
Price leadership happens at every level. Even companies which focus on a specific market niche are grouped together in an industry with like-minded firms.
There are times when price leadership is an effective strategy to secure a greater share of the market. There are also times when price leadership will drive consumers away. That is why the advantages and disadvantages must be carefully weighed before deciding on a strategy in this category.
There can only be one price leader in an industry.
List of the Advantages of Price Leadership
1. It can secure a higher profit margin for the company.
Pricing strategies can go lower or higher, depending on what a company wants to accomplish. If they were able to take the lead on a pricing strategy that had a higher price point for consumers, it opens the door to an improved profit margin on the goods or services. The rival firms in this scenario would also raise their prices to match what the price leader’s actions were on comparable products.
2. It can secure a larger market share.
Pricing strategies that go lower are intended to improve the market share a company receives for a specific product or service. Rivals may choose to set a lower price than the price leader as a way to coax more customers to switch their brand loyalty. New rivals may set lower prices to disrupt the market as a way to gain attention for what they’re offering. If others move to match these price points, then it shifts who holds the leadership position in the market.
3. It stops other companies from entering the market.
If the price leaders are able to control pricing levels for goods or services at an extreme level, high or low, then it becomes difficult for other rivals to enter the market as disruptors. That is because the ability to effectively undercut the leader with a comparative product or service is almost impossible. On low prices, the profit margins are too low. On high pricing strategies, the value proposition offered by the new rival is often too low.
List of the Disadvantages of Price Leadership
1. It requires everyone to be ready to follow the leader’s position.
Price leadership only works well when everyone in the same market is ready to follow the lead of the initiating company. Even if one SMB or SME decides to go against the pricing position, it will create a disruption in the market that may affect the integrity of the leadership position. That is why most price leadership actions move prices upward unless the leader is trying to secure a greater market share from their competition for some reason.
2. It requires industry expertise to be effective.
Price leaders must be able to identify specific trends within their industry to make pricing shifts effective. Many companies rely on the expertise of the leadership company to make their own decisions because it helps them to save money, since they don’t need to invest into resources that help them acquire the same expertise. If the price leaders get the decision wrong, because there is such reliance on their actions, an entire industry can go under quickly.
3. It may affect the quality of the product.
One way that price leaders attempt to retain their profit margins is to cut costs at other points within their product or service chain. The goal is to produce an acceptable product, not an exemplary one, which then reduces the “elite-ness” of the brand. It would be like Apple deciding that they’d offer a $1,000 iPhone that offers a camera, some apps, and the ability to text, but nothing more. It would be okay, but it would not be an elite product.
4. It can force small businesses into bankruptcy.
Although large companies can use price leaderships to raise prices, most undisputed market leaders do they opposite. They use their size and scale to keep marking prices downward as a way to eliminate the competition. Smaller rivals are forced to price items so low that they cannot make a profit since they operate on a different economy of scale. Over a prolonged time, price leadership in this manner can often put small businesses into bankruptcy or close their doors permanently.
5. It may create complacency.
Companies that are successful in exercising a price leadership strategy may find themselves in a comfortable situation within their market. With comfort comes inefficiency. Many companies find that when they are in a leadership position, their cost structures begin to erode over time. If enough erosion occurs, then it may be difficult to earn a profit in the future if a rival attempts a price war. To counter this issue, companies must be proactive in maintaining their production and cost structures to ensure continuing success.
6. It is usually a reactive decision instead of a proactive one.
Most industries accept a price leader because they are unwilling to take the role on themselves. It is a defensive position which requires all participants to monitor each other constantly. If someone makes a move, then everyone else reacts by making a similar move. The only companies that usually win when price leadership is being used are the ones that are proactive about shifting their pricing mechanisms. If you’re not the first to shift prices, then you’re not a leader. You’re a follower.
7. It can be seen as collusion.
Companies that raise prices when others do often lose a share of their business. This happens because customers see the businesses as being in collusion with each other. From an outside perspective, it looks like all the companies got together to find ways to charge more for what is being sold. Even in markets where the price leader has an overwhelming market share, the smaller rivals will often see lower customer turnout because of this issue.
The advantages and disadvantages of price leadership show us how companies are able to direct consumer spending habits. Price is only one component of the value equation. At the end of the day, the companies which offer the best value will be the ones that gain their market share. By identifying what core consumers find to be valuable, price leaders can set costs accordingly and help (or hurt) their industry.