2.1 Goals
Strategy is the art and science of developing and deploying all of a company’s resources so as to achieve the most profitable long-term survival of the company. Strategy is all-encompassing and affects all functions. A company’s strategy must embody a high-level vision for the firm, but it must also be concrete and practical. Developing strategy starts with the company’s goals, from which specific objectives for managing each aspect of its business, including price, can be derived. Having clear, unequivocal goals and targets is an indispensable prerequisite for professional price management. While this may sound simple, developing such clear strategic goals can be difficult in practice. Objectives for price policies are not always clearly formulated and may occasionally give greater weight to unspoken goals than to explicit ones.
Profitability goals (profit, return on sales, return on investment, shareholder value): Most companies pursue profitability goals in a more or less well-defined form. While short-term profitability goals often differ, ultimately, the most important long-term goal is to increase shareholder value.
Volume and growth goals (volume, market share, revenue, or revenue growth): Volume and growth goals are alternative goals or proxies for long-term profit maximization or growth in shareholder value. Since its founding in 1994, Amazon has focused almost exclusively on growth and, as a result, has not made any significant profit in its first two decades. In 2015, the company achieved an after-tax profit of $596 million on revenue of $107 billion, which corresponds to a margin of 0.56%. In 2016 Amazon’s revenue increased to $136 billion and its after-tax profit to $2.37 billion, corresponding to a margin of 1.7%. By the beginning of 2018, Amazon’s market capitalization had almost doubled in 3 years to $669 billion, an immense increase in shareholder value.
Financial goals (liquidity, creditworthiness, debt-to-equity ratio): These goals come to the fore in particular for new companies short on capital or for any company facing a crisis.
Power goals (market leadership, market dominance, social or political influence): Volkswagen sets itself a singular goal: outsell Toyota. It is often said that Google wants to dominate the markets it enters. Peter Thiel’s bestseller “Zero to One” encourages companies to find niches they can monopolize. Fighting and beating the competition is a very common goal of managers.
Social goals (creating/preserving jobs, employee satisfaction, fulfilling a grander social purpose): In line with such goals, a company will sometimes accept orders at prices which do not cover costs, in order to avoid cutting jobs. Companies may also cross-subsidize products or services in order to make them accessible to target segments who otherwise might not be able to afford them—for instance, providing student or senior citizen discounts. For Patagonia, the maker of outdoor and athletic gear, environmental sustainability is a core part of the mission. Patagonia donates employee time, services, and at least 1% of sales to grassroots environmental groups all over the world in service of its social goal.
Almost all goals have an effect on price management, though price is certainly not the only instrument companies use to achieve their goals. In the pursuit of growth goals, a company might rely on innovation, or it could set aggressive low prices. Companies can meet profit and financial goals through cost-cutting, or they could raise their prices. To fulfill their power goals, companies might wage a price war or take control of a distribution channel. In most cases, price makes an important contribution to achieving a company’s strategic goals.
Goal conflict: Profit growth, volume growth, or both?
Quadrant I shows the “manager’s dream”—profit and volume are both growing simultaneously, a situation most frequently encountered in expanding markets or with new products just achieving economies of scale. For a mature market that is no longer growing, the manager’s dream can only occur when a company’s prices are too high and are cut as a result. In that case, the lower prices lead to a significant increase in volume, overcompensating for the lower margin, and generating a higher profit.
In practice, we observe the situations in quadrants II and IV quite often. A company achieves either profit or volume growth, but not both. Quadrant II represents rising profit and declining volumes. In this case, the company’s prevailing prices were below the optimal level. Increasing the prices leads to a volume decline, but the higher contribution margin more than offsets that decline and results in a higher profit. In Quadrant IV the profit decreases, but the volume grows. This situation occurs when a company’s prices were either at or below their optimum and then get cut. In Quadrant II as well as in Quadrant IV, management must choose between the countervailing profit and volume changes. No matter what, managers should avoid Quadrant III, which we refer to as the “manager’s nightmare.” If prices are already too high and are then increased even more, the result may be a decline in both profit and volume.
Contradictory goals among senior leaders
Senior leader | Profit | Growth | Market share |
|---|---|---|---|
Chief executive officer | 1 | 3 | 2 |
Chief financial officer | 2 | 1 | 3 |
Head of sales | 1 | 2 | 3 |
Head of marketing | 2 | 3 | 1 |
Product manager | 3 | 1 | 2 |
Results of the PIMS study [1]
A second and somewhat older justification for the pursuit of high market shares is the concept of the experience curve, which states that the cost position of a company is a function of its relative market share. The relative market share is defined as one’s own market share divided by the market share of the strongest competitor. According to the experience curve hypothesis, the larger a company’s relative market share is, the lower its unit cost will be [2]. The market leader has the lowest costs in the market and thus—assuming the same prices across competitors—the highest returns.
The experience curve concept and the PIMS study are the grandparents of all market share philosophies. Jack Welch, CEO of General Electric from 1981 to 2001, became their most famous proponent. At the beginning of his tenure, he declared that General Electric would withdraw from all sectors in which it could not attain the number one or number two position in terms of market share.
The central question is whether the link between market share and returns reveals a true causal relationship or merely represents a correlation. Numerous studies have called into question whether a causal relationship actually exists. The results in fact show a much weaker link between market shares and returns than what the authors of the PIMS study postulated. Farris and Moore [3] provide an overview of the insights. Analytical methods which filter out so-called “unobservable” factors lead to the following conclusion: “Once the impact of unobserved factors is econometrically removed, the remaining effect of market share on profitability is quite small.” These “unobserved” factors include the capabilities of a company’s management, the corporate culture, or a sustained competitive advantage. Ailawadi et al. [4, p. 31] conclude: “Although high market share, by itself, does not increase profitability, it does enable high-share firms to take certain profitable actions that may not be feasible for low-share firms.” A study by Lee [5] likewise comes to the conclusion that not more than 50% of a company’s profitability can be explained by absolute size and that other factors play the decisive role for return on investment. “While a typical firm’s absolute size matters for its profit experience, perhaps some other factors matter even more” [5, p. 200].
The most comprehensive meta-analysis on this topic to date comes from Edeling and Himme [6]. They examined 635 empirically calculated elasticities for market share and profit which reflect the percentage change in profit when market share increases by 1%. Here we note that these calculations measure changes in the starting values in percent and not percentage points. The authors found that the average elasticity for market share and profit is very low, at 0.159, but statistically significant. The following example demonstrates the findings of their study. Let us assume a company has a market share of 50% and a profit margin of 10%. If the market share rises by 1–50.5%, the profit margin rises only to 10.0159%. If the market share rises by 10–55%, the profit margin would increase to 10.159%. In a further step, Edeling and Himme [6] eliminated the skewing induced by his analytical methods and arrived at a slightly negative adjusted average market-share-profit elasticity of −0.052, which was not statistically significant. These results more than call into question the validity of the “market share is everything” philosophy.
Older studies considered the effects of competition-oriented corporate goals (such as market share or market position) more thoroughly. Lanzillotti [7] conducted a well-known study of this kind. It revealed a negative correlation between the pursuit of competition-oriented goals and a company’s return on investment. Armstrong and Green [8, p. 2] concluded that: “Competitor-oriented objectives are harmful. However, this evidence has had only a modest impact on academic research and it seems to be largely ignored by managers.” We find additional empirical evidence for a negative link between the pursuit of market share and the success of a company in a study from Rego et al. [9]. Using data from 200 US companies, the authors identified a trade-off between the pursuit of higher market share and higher customer satisfaction, which itself is seen as an important driver of long-term profitability [10]. The authors explain this through the heterogeneity of consumer preferences: the larger a company becomes, the harder it is for the company to meet consumer preferences. These are only a few studies among many which have explored the effects of market share goals, the experience curve, or portfolio management based on the “Boston Matrix.” For many other arguments against the “market share myth,” we refer the reader to the book “The Myth of Market Share” by Miniter [11]. In summary, the pursuit of volume and market share goals—especially in mature or highly competitive markets—is problematic and in many cases prevents a company from earning higher profits.
A company’s size can make it difficult to increase revenue. A growth goal of 50% for a company with $10 million in revenue means an increase of only $5 million. For a company with revenue of $150 million, the same goal would call for a revenue increase of $75 million. Once a company reaches a certain size, there may not be a sufficient number of customers or suppliers to enable further rapid growth.
Albert M. Baehny, the non-executive chairman and former CEO of Geberit, also disagrees with the supposed importance of market share: “I am not interested in market share. In my career, I hardly ever looked at market share. If the price-value relationship is good, the demand will follow” [12]. Geberit is the global market leader for so-called behind-the-wall sanitation products and has a market capitalization which is roughly five times its annual sales. Baehny emphasized that when his company decides whether to introduce a new product, it does not look at the product’s market potential or achievable market share. According to him, such forecasts are too unreliable. Instead, Geberit identifies the product’s value to the end users and uses that metric to ensure a sufficient willingness to pay for the product.
In our view, what matters is not the absolute level of the market share but how a company achieves its market share. If that market share comes through aggressive prices without a correspondingly low-cost base, then a company has “bought” that market share at the expense of its profit margins. This is true for many start-ups, which spend exorbitantly to acquire customers in the hope that they will one day be profitable at scale. However, it means per se that in most cases, the company will not earn much profit. If the company achieves its high market share through innovation and quality at appropriate prices, then margins and profits are healthy and aligned. The high profit in turn allows the company to make additional investments in innovation and product quality. Recent studies, such as one from Chu et al. [13], examine the link between market share and profitability in a homogeneous sector (insurance) and confirm this strategy: a company can improve its profitability by developing new services or technologies or by growing market share through acquisitions.
It is clear that balancing profit and volume goals is necessary for price management. In the early stages of a market or a life cycle, it can make sense to give greater weight to volume, revenue, or market share goals. In the latter phases of the product life cycle, a company should put higher priority on profit goals. Ultimately, management should orient itself toward long-term profitability.
2.2 Price Management and Shareholder Value
Profit and growth drive shareholder value. Because price exerts a strong and decisive influence on both profit and growth, price is a crucial determinant of shareholder value. More and more managers have begun to recognize this connection. They have incorporated it into their strategic planning as well as into their communication to the capital markets [14]. Investor Warren Buffet’s claim that pricing power is the most important criterion for determining the value of a firm has boosted this trend. Well-known Silicon Valley investor Peter Thiel likewise stresses the connection between price and shareholder value, as he is decidedly in favor of using pricing power to expand a market position [15].
As we will see, price management can dramatically impact shareholder value, both positively and negatively. Good price management fosters a significant increase in enterprise value. Mistakes in price management can destroy enterprise value. The following cases prove that the destructive effects take hold much more rapidly than positive (long-term) growth in enterprise value.
Price discipline and share price of a telecommunications company [16]
The company’s CEO greeted the stock market’s positive response by saying: “We are very satisfied with our disciplined approach to pricing. The results reflect a positive dynamic in our industry, which includes diminished price pressures.” Investment analysts also praised the newfound price discipline. “The rise in wholesale prices reflects the trend toward reduced price pressures, a very healthy development. More stable prices should help all market participants,” said one report.
Another case involves a group of private equity investors who owned a large operator of parking garages. The investors planned to use price management to increase the value of that operating company prior to divesting it. They succeeded in implementing price increases and built the new prices into the contracts with the local garage lessors, thereby locking in an additional profit of $10 million per year. Shortly after this price action, the investors sold that company at a multiple of 12 times profit. The price increases led directly to an increase of $120 million in enterprise value.
A third case looks at the market for luxury goods. The French company Hermès is known for its strict commitment to high prices and the avoidance of price erosion in any form. The Wall Street Journal writes that: “Hermès bets on higher prices while others even cut their prices” [17]. In contrast to other luxury goods companies, Hermès sticks to this strategy even in economic downturns and crises. While the JBEF Luxury Brands Index did not move from 2015 through March 2017, the share price of Hermès almost doubled in the same period. The company’s consistent price strategy made a decisive contribution to that increase.
Share price of Praktiker [19]
What is interesting is that during that same time period, other home improvement chains flourished and were able to increase their revenues. The Praktiker case shows that a company should carefully consider the potential consequences of building a market positioning exclusively around low prices. This strategy and the subsequent attempt to overcome its consequences both ended badly for Praktiker. Praktiker went bankrupt in the fall of 2013 and no longer exists.
Share price of Uralkali [20]
Share price of J.C. Penney [22]
Marketing science has historically conducted scant investigation into the relationship between marketing instruments and shareholder value. In recent years however, this has begun to change for the better. In a meta-analysis of 83 studies, Edeling and Fischer [10] found that advertising has a slight positive effect and that so-called marketing-asset variables (which include brand and strong customer relationships) have a significantly stronger effect on shareholder value. The median elasticity was 0.04 for advertising and 0.54 for the marketing-asset variables. In other words, a 1% improvement in marketing generates an increase of 0.54% in enterprise value. Price was not explicitly studied in the meta-analysis, so it is not possible to say anything about the price vs. shareholder value elasticity. Two additional studies looked at how price actions and innovation affect shareholder value. Pauwels et al. [23, p. 142] came to the following conclusion: “New product introductions increase firm value, but promotions do not.” The findings from the study conducted by Srinivasan et al. [14] point in the same direction. Innovations and marketing support for them drive higher enterprise value, but price actions (i.e., discounts or aggressive price moves) have a negative effect. Our own experience leads us to support these findings emphatically.
These elaborations and empirical insights prove the strategic relevance of price management for the value of an enterprise. With the help of the right price strategy, a company can increase the enterprise value. At the same time, the wrong price positioning can reduce shareholder value and can even—as the case of Praktiker shows—destroy it completely and forever.
2.3 Value and Price
The core questions of strategic price management concern value and price positioning. We are asked again and again what the most important aspect of price management is. We always give the same answer: “value-to-customer. ” The price a customer is willing to pay, and thus the price the seller can achieve, is always a reflection of the customer’s perceived value of the product or service. If customers place a higher value on the product, then they are prepared to pay more. If the perceived value is lower than that of a competing product, they will only buy the product if the price is also lower (relative to the competitive product). This unwavering market view was best expressed by Peter Drucker, who urged managers to “see the entire business through the eyes of the customer” [24, p. 85]. When it comes to the price that a seller can achieve, the most relevant parameter is the customer’s subjective perception of value.
Create value : Innovation, product quality, the standards and nature of a product’s materials and components, design, etc., all contribute to value creation. The choice of customer segments also influences value creation, because customers have different requirements and different perceptions.
Communicate value : Statements about the product, its position, and last but not least about its brand all communicate value. Value communication includes packaging, product presentation, and placement at shelf or online.
Retain value : The degree to which a product retains its value will influence first-time willingness to pay for consumer durables. For luxury goods and automobiles, value retention—resale value—can even constitute a deciding factor for initial willingness to pay.
Only when a seller has clarity on the value of the product or service can the seller approach the specifics of price setting. When establishing value—which in practice spans a very wide range from highest to lowest quality—the seller or supplier must be mindful of the achievable price from the very beginning. Ramanujam and Tacke [25] insist in their book “Monetizing Innovation” that companies should design a product around a price. In other words, they should start with the price range and then begin with research and development, designing a product with the appropriate features and quality for that price range. Putting effort into understanding value is likewise important for the buyer. The only way for buyers to avoid overpaying is to understand the value of what they are buying. This knowledge of value protects the potential customer from buying a product which looks like a bargain at first glance but upon use or consumption turns out to be a lemon [26]. The Spanish philosopher Baltasar Gracian (1601–1658) stated this sentiment eloquently and succinctly: “It is better to be cheated in the price than in the quality of goods” [27]. Ripping off a customer by charging too high a price is infuriating for the customer—but this anger is often only temporary. Selling a buyer goods of poor quality, however, causes the anger and frustration to linger until the customer grows tired of the product and disposes of it. The moral of this story is that when negotiating and making a purchase, the buyer should pay more attention to the quality of the product or service than to its price. Admittedly, that is not so simple in practice. It is generally easier to judge whether a price is advantageous than to judge the full merits of a product or service.
A French saying echoes this sentiment: “Le prix s’oublie, la qualité reste,” which essentially means that quality endures long after you have forgotten the price. It is not uncommon for prices to be ephemeral and quickly forgotten, while impressions of value and quality last much longer. Who has not hastily celebrated capturing a bargain or paying a low price, only to find out later that quality was poor and the bargain an illusion? Conversely, who has not at least once complained about paying a high price and then been pleasantly surprised when the quality turned out to be excellent? The English social reformer John Ruskin (1819–1900) described this insight succinctly: “It is unwise to pay too much, but it is worse to pay too little. When you pay too much, you lose a little money—that is all. When you pay too little, you sometimes lose everything because the thing you bought was incapable of doing the thing you bought it to do. The common law of business balance prohibits paying a little and getting a lot—it cannot be done. If you deal with the lowest bidder, it is well to add something for the risk you run, and if you do that you will have enough to pay for something better” [28]. Buyers who choose the lowest-priced suppliers may not be aware of or heeding Ruskin’s wisdom.
2.4 Positioning
Potential price positions
A product’s positioning should never be based solely on price but should rather reflect the underlying basis of the product’s or service’s value, including its brand. Positioning, in this sense, is synonymous with “price-value positioning” or “price-performance positioning.” A product’s positioning provides the fundamental orientation and leeway for price decisions. The positioning can apply to the entire firm, to a particular brand, to a product group, or even to an individual product.
Functional
Emotional
Symbolic
Ethical
Functional attributes apply to each performance element of the product or service with respect to its ability and suitability to satisfy the customer’s needs [30]. The functional attributes enable the customer to solve a specific core problem or mission, i.e., for an airline the problem of transporting passengers from point A to point B. Functional performance would also encompass the resources and infrastructure necessary to meet these transportation needs. For a smartphone, attributes such as screen size and battery life comprise the functional performance. For a laptop computer, functional attributes include the processor speed and the amount of memory.
Emotional attributes refer to the value that the customer derives from the product because of positive feelings the product elicits. Needs such as the desire for change or escape, excitement, sensory pleasure, sensual experiences, or beauty are fulfilled by emotional attributes [30]. For a car, this can mean the fun of driving a sports car or the pleasure from appreciating the car’s aesthetics and design. Customers feel pleasure or even excitement when they spend a night at a luxury hotel, and these count as emotional benefits. A product’s or service’s ability to stimulate emotions can have a pronounced effect on the willingness to pay.
Symbolic attributes refer to the value a customer gains from a boost in confidence or self-esteem from the product or service. These attributes allow customers to associate themselves with a group or person, express their belonging (actual or desired) to a particular group, or conversely, to separate or distinguish themselves from a group. They also fulfill the need for social recognition or serve as a form of self-expression [30]. Brands play a very important role as symbolic attributes. A very expensive watch, say from Rolex, or an exclusive suit from Zegna, confers social prestige and creates the impression that one belongs to a certain social class. This symbolic performance, in the sense that it signals membership in a certain group, is a powerful driver of willingness to pay. Similarly, driving a Porsche vs. driving a Toyota Prius sharply conveys different symbolic attributes.
Ethical attributes include those which foster the positive feeling that one has done something beneficial for others, for society, or for the environment. These attributes are the focus of mission-driven brands. This feeling likewise provides customer value, as the other three categories of performance attributes do. Through these attributes, one expresses and fulfills one’s desire to help others in a specific way or manifests the general desire to act morally or altruistically [30]. Examples of ethical performance include Procter & Gamble’s “One-Pack = One Vaccine” campaign, under which the company pledged to provide UNICEF with funding for one lifesaving tetanus vaccine to protect a mother and her newborn in the developing world for every package of Pampers diapers purchased in the United States or Canada. Other such examples are the drinking water initiative from the Volvic water brand and the Breast Cancer Awareness Campaign sponsored by Estée Lauder. These companies attract customers through a commitment to support charitable initiatives or serve a larger social cause. This commitment can influence the willingness to pay.
Overview
Each of these four types of performance attributes is capable of fulfilling customer needs and thus of generating willingness to pay. This means that the nature or extent of a product’s performance must always be incorporated in its positioning. All marketing instruments and other corporate activities such as R&D, procurement, and even the selection of personnel should be consistent with the price position for which the company is striving. A company needs a fundamentally different showroom and a different caliber of salesperson for luxury cars than it does for low-price models. In addition to this consistency, a company also needs endurance, because it can take years to establish the desired price position.
2.5 Approach
Price and value should always be seen relative to each other. As Fig. 2.7 shows, one must interpret the price position from the perspective of the price-performance or price-value relationship. The consistency band in Fig. 2.7 illustrates the ultra-low, low, medium, premium, and luxury price positions. The dimensions of price and performance are at different levels for each position, but in balance with each other. The perception of the customer is the factor which counts.
Deviations from the consistency band may be viewed as fair or unfair in the eyes of the customer. A fair or advantageous position (again, in the eyes of the customer) reflects a favorable price-performance relationship. The customer perceives a surplus of performance relative to price. The unfair position results when the seller demands a high price which is not aligned with the perceived value or performance. A Dutch customer’s comment on a German engineering firm illustrates this: “Your price is 1.2 million euros. The price from a Chinese supplier is 750,000 euros. I realize that your product is better, but it is not 60% better. So I will not pay 60% more.” The Dutch customer bought the Chinese equipment.
In 2016, Sprint began to use that same kind of quantification and logic to its advantage in its advertising campaigns. Under the slogan “Don’t let a 1% difference cost you twice as much,” Sprint presented data which show that its network reliability is within 1% of the performance of competitors such as AT&T and Verizon, but its plans are 50% less expensive. Some companies, meanwhile, are criticized that their price-performance relationship is out of whack, even in the absence of numbers for comparison. McDonald’s is one example, as one observer remarks. “Nowadays the Big Mac in America costs $4.80. The price-value relationship is completely off” [31].
To develop solid price positions for a product or service, we recommend a three-step approach. First, a company should make a rough segmentation of its market from a price-performance perspective. Start by delineating the market, including an analysis of customers and competitors. A valid market segmentation is an indispensable prerequisite for successful price positioning. Within the framework of the company’s strategic direction, the company then selects one or more target segments and the appropriate price position for each one. Related to this task, the company must also decide whether it will use one brand or multiple brands to cover the different price positions. When Apple launched its smart watch in 2015, the “Apple Watch” brand served several segments across an extreme price range from $349 all the way to $18,000 per watch [32]. Later the watches were available between $249 and $1399. Apple removed the “luxury” edition from the assortment.
In saturated markets or markets where market fragmentation is increasing, a rough segmentation is usually not sufficient. Within a chosen price range, one must further differentiate from the competition. A premium supplier can examine whether it has enough price leeway to extend into the luxury segment. In a similar way, at the lower end of the price scale, there may be additional demand at prices below the current price levels. No-frills airlines and hotels have greatly expanded the overall travel market with low-price positions.
In the low-price segment, the functional attributes tend to dominate. Customers in these segments are interested in basic products and services, such as economical transportation. Additional performance attributes such as a powerful engine, comfort, sportiness, aesthetic design, or prestige play a secondary role. In the premium segment, customers demand not only a higher level of performance on the functional attributes; they also give increasingly greater weight to emotional, symbolic, and ethical attributes. Buyers of electric cars put symbolic and ethical attributes at the forefront of their decision-making. Such customers will only develop the appropriate willingness to pay when these attributes fulfill or exceed their expectations.
Price positioning must be regarded as a strategic decision because of the inherent risks involved. Because price positioning is established for the long term, it is very difficult to correct mistakes. Despite this, improper positionings are not uncommon in practice. The so-called “Personal Transporter” Segway, a revolutionary innovation and cult product, was introduced in 2001 at a price of $4950. Nowadays, the least expensive model i2 SE costs $6694, which one can confidently declare to be a luxury positioning for that kind of vehicle. Sales projections called for 50,000 units in the first year and average annual sales of 40,000 units in the first 5 years. In reality, the company sold only 4800 units per year in the first 5 years after launch. They fell short of the original volume target by 88%. The primary cause for this shortfall was probably the product’s misaligned price positioning [33].
In 2014, Amazon introduced the “Fire” smartphone at a price of $200. This launch price reflected a medium-price positioning between basic Android phones and the more expensive iPhone. Yet no one bought the “Fire” at that price. Amazon responded by cutting the price to just $1, but even this radical move could not save the product. Amazon wrote off $170 million as a result. Apparently, Amazon was way off in its estimates of consumers’ willingness to pay [34].
Similarly, the luxury goods brand Gucci failed to assess its potential customers correctly when it assumed that a higher price would automatically make the brand even more luxurious and sought after. The attempt to raise handbag prices by then-CEO Patricio di Marco proved to be unsuccessful due to a miscalculation regarding customers and their preferences. The case shows that a price increase alone does not create or improve a luxury brand [35]. Successive price increases by the British leather goods maker Mulberry brought sales to a virtual standstill. Customers found one price increase of several hundred pounds particularly unjustified. The image of the brand simply did not live up to the prices the company was charging. Declining revenue and frustrated customers prove that a price repositioning cannot be effected over a brief period. The positioning must unfold as a long-term process both within the company and in the eyes of the customers [36].
We have also witnessed numerous cases in which a company chose a price position which was too low. Playmobil priced its new “Noah’s Ark” set at €69.90. The product soon sold on eBay for €84.09, a clear indication that the product’s price position was too low. In 2014, Microsoft launched the hybrid tablet Surface Pro 3, which could completely replace a laptop. The tablet sold out immediately. The primary reason was a price position which was too low relative to competitors such as Apple and Samsung. The British firm Newnet introduced an “uncapped service” for £21.95 per month, but the first 600 customers immediately used up all available capacity. As a result, the company raised the price by 60% to £34.95. The Taiwanese computer maker Asus launched the mini-notebook “Eee PC” at €299, and similar to Microsoft’s tablet, this product sold out within a few days. During the launch phase, the company could only satisfy 10% of the actual demand.
The Audi Q7 was also positioned too low, entering the market at €55,000. The company received 80,000 orders against an annual production capacity of only 70,000 units. Procter & Gamble overhauled the pricing for its Olay “Total Effect Creme,” raising the price by 375% from $3.99 to $18.99. The creme sold even better than before at the much higher price. Subsequent products received the same positioning in this higher price segment. Procter & Gamble succeeded in boosting the Olay brand from a low-price to a medium-price position [37]. These cases illustrate the enormous significance of finding the optimal price positioning when launching a new product.
2.6 Price Positions
In this section we will elaborate on the five basic options for price positioning. We will look at the following categories: luxury, premium, medium, low, and ultra-low. We start with the luxury segment.
2.6.1 Luxury Price Position
2.6.1.1 Basics
Examples of luxury and premium price positions, Status: February 2018
Product | Premium price position | Luxury price position |
|---|---|---|
Wristwatch | Michael Kors Ceramic MK5190, $348 | A. Lange & Söhne, Lange 1 Tourbillon Platinum, $403,000 |
Car | BMW 7 Series, base price $83,100 | Ferrari 458 Italia, base price $264,000 |
Hotel | Hilton New York Midtown, $269 | Burj Al Arab Dubai, Royal Suite, $13,058 |
Flight | Lufthansa Business Class, Frankfurt to Moscow $1031 | Lufthansa Private Jet, Frankfurt to Moscow, $20,794 |
T-shirt | Ralph Lauren, $79 | Prada, $740 |
Another distinction for luxury goods is their unit sales. Among true luxury goods, annual global unit sales often total only a few hundred, perhaps a few thousand, while premium products can generate volumes in the hundreds of thousands or even millions of units. Rolls-Royce sold only 4011 cars in 2016. Ferrari limited its sales volume in 2016 to 8014 units. In contrast, Porsche shipped 237,800 new vehicles in 2016. Although all three brands belong to the luxury segment, their sales volumes vary dramatically. Luxury goods markets have seen strong growth over the last several years and show high returns. There are more millionaires and billionaires in the world today than ever before. The price trend for luxury goods over the last 25 years is interesting. The average price of exported Swiss watches has increased by around 250% since 1990 [39]. Some luxury goods makers such as Bentley are trying to take advantage of this trend and improve their sales numbers. Bentley had already boosted its volume in 2013 by 19% to 10,120 units and maintained that level in the ensuing years. In 2016 Bentley sold 11,023 cars.
The world’s largest luxury products group, LVMH, posted an EBIT margin of 19.5% in 2017, and its revenue has grown by around 10% per year since 2007. The Swiss luxury goods firm Richemont, the number two in the world, had an EBIT margin of 16.6% in the fiscal year 2017. Its average annual revenue growth since 2007 is around 9.2%. Profit and growth are the drivers of shareholder value [40]. The market capitalizations of these two firms reflect this. LVMH’s sales of $52 billion and a pre-tax profit of $10.2 billion in 2017 helped sustain a market capitalization of $144.89 billion (as of February 2018), which is four times the firm’s 2007 market cap of $35 billion [40]. Richemont had a market cap of $51 billion on sales of $13 billion and a pre-tax profit of $2.2 billion [41]. That is likewise more than three times its value in 2007. Despite their attractiveness with regard to profit and growth, luxury goods remain a niche market, albeit an extremely lucrative one.
2.6.1.2 Management
Product
Luxury goods must offer the highest performance and the best quality across all attributes. That applies to functional, emotional, and symbolic attributes. Johann Rupert, the chairman of Richemont, says: “We understand that we have to produce exciting and innovative products combined with excellent service to meet the demand of an ever more discerning clientele” [42]. They combine perfection in detail and opulence with excess in many facets. Burmester, which makes luxury audio systems, has developed and patented a device which can “clean” electricity. The “power conditioner” preserves and improves sound quality by filtering out the slight residual DC current mixed with the AC current from the power mains. Luxury goods do not necessarily differ from premium products in terms of functional performance. An international study of 28 leading manufacturers of luxury goods revealed that brand image, quality, and design are the main differentiation criteria, not higher functional performance [43].
Personalized service is an integral part of the luxury goods experience. At Burj Al Arab, guests staying in suites have their own butler team available 24 h a day. Leica manufactured gold-plated cameras for the Sultan of Brunei. Each year, Louis Vuitton produces around 300 custom-made special editions for prominent or exclusive customers. The process takes between 2 and 4 months for each piece. Such products include cases for two champagne flutes or for a collection of valuable batons. Things which would be considered extras for premium products are standard for luxury goods.
Luxury goods can actually have some conflicts when it comes to ethical attributes. The Bugatti Chiron, whose 16-cylinder engine delivers 1500 horsepower, has a price tag of $2.7 million. But similar to a private jet, the Chiron is certainly not considered an environmentally friendly vehicle.
Handmade is another hallmark of luxury goods. By nature, hand manufacturing limits production volume but gives the product a personal and individual character. In order to maintain full control over quality and the production process, luxury goods manufacturers tend to be highly vertically integrated and avoid outsourcing. They seek to apply strict controls of their supply chain. Hermès even has its own cattle farms and stitching departments. When Montblanc decided to enter the market for luxury watches, it added its own handcrafting facility in Switzerland. Some customers become so devoted that they make pilgrimages to such facilities. This intensive focus on handmade production and unique pieces offers small firms an opportunity in the luxury segment when they would have little chance of success in the mass market. One example is the Welter Manufaktur in Berlin, which specializes in wall decor. For their customized work, they charge between €1000 and €3000 per square meter. Despite these high prices for wall decor, the German firm has established itself in the international luxury market. It did the walls for the department store Harrods in London as well as the World Trade Center in Dubai [44].
Luxury goods makers rely on dedicated product life cycle management to ensure that their products retain their value. Ideally, a luxury product will appreciate in value over time. Limited editions and collectors’ editions enhance this effect and help provide the desired exclusivity. In 2011, a Hermès Birkin Bag fetched a price of $150,000 at one auction. The original prices for the bags were between $5300 and $16,000.
Price
“Nothing is too beautiful, nothing is too expensive” is the tagline for Bugatti. Nick Hayek, the head of the Swatch Group, says that “there are no limits for luxury goods” [45]. One would imagine, therefore, that pricing of luxury goods could not be simpler: set the price as high as possible. But this simplicity is an illusion. In reality, price management for luxury goods demands very deep knowledge of the customers and the market as well as a delicate balancing act between volume and price.
The price itself is an outstanding indicator of quality and exclusivity for luxury goods. The so-called snob and Veblen effects result in a price-response function with a positive slope over some price intervals [46]. In other words, price increases lead to higher, not lower volumes. Profit rises due to the simultaneous effects of higher unit margins and higher volumes. Such cases really do occur. Delvaux, a Belgian manufacturer of exclusive bags, undertook a massive price increase as part of its repositioning. As a result, sales volumes rose sharply because customers began to view the products as relevant alternatives to Louis Vuitton bags. The effects of a luxury positioning are not limited to consumer goods. The effects can happen for industrial goods as well. The “Hidden Champion” Lightweight, which produces luxury carbon wheels, sells them in sets which cost between €4000 and €5000. These are not meant for the consumer market but rather for professionals. Lightweight does not grant any discounts. Yet demand for the wheels continues to rise [47]. Similar performance attributes played a decisive role in Porsche’s price setting for its innovative line of carbon brakes. Within the company, the price of $8520 as an option for the Porsche 911 model was initially viewed as too high. But the market accepted the price, exhibiting high demand for these yellow brakes. Relative to the usual red brake discs, the yellow ones signaled the status of the car owner and thus served as a symbolic attribute. Despite the considerable price premium, the carbon brake sets became a “must have” for many Porsche 911 owners [48].
The part of the price-response function with the positive slope, however, is not relevant for price setting. The optimal price always lies along the negatively sloped portion of the curve. Luxury goods manufacturers need to know their price-response functions if they want to reach that optimal zone for price setting. Without this knowledge, they are stumbling around in the dark.
In order to support the very high price levels, companies usually limit production. This decision is made up front and communicated to the market. The limiting of an edition therefore becomes binding. Violating this self-imposed limit, for instance, in the case of unexpectedly high demand, can be a severe breach of consumers’ trust. Thus, Bugatti plans to make no more than 500 Chiron vehicles. Montblanc restricts its series of fountain pens dedicated to US presidents to 50 pens per president. Depending on the design, such pens cost $25,000 and up. Very expensive watch models are often limited to 100 pieces or fewer. A. Lange & Söhne made only six units of the most expensive watch at the 2013 Geneva Watch Salon. The price tag was just under €2 million apiece.
Long waiting lists and delivery times enhance the impression of both scarcity and enduring value. Patrick Thomas, the former CEO of Hermès, described the phenomenon: “Indeed we have to deal with a paradox in our branch: the more desirable you are, the more you sell. And the more you sell, the less desirable you are. That is why at times we stop the production of a tie once it becomes too successful. Simply because success may denote triteness” [49]. Some luxury goods manufacturers carefully select their customers in order to prevent the wrong customers (e.g., seedy guests at a luxury hotel) from harming the brand’s image.
The joint setting of prices and volumes for luxury goods is fundamentally different from the approach taken in other markets. In raw commodity markets, suppliers must accept the prevailing price and can only decide how much volume to put on the market. In non-commodity markets, the supplier sets the price, and the market decides how much volume it is willing to absorb. In luxury goods markets, suppliers set both the price and the volume. This combination requires a very high level of information and carries considerable risks. The following real-world case illustrates this. A luxury watchmaker presented a new watch at the watch trade fair in Basel (the world’s largest) and limited volume to 800 pieces. Because the preceding model was highly coveted, the watchmaker raised the price for the new model by 50% from €16,000 to €24,000. At the trade fair, the company received 1500 orders for the new model. At a price of €24,000 and a total run of 800 timepieces, the company would have generated €19.2 million in revenue. If it could fulfill all 1500 orders placed, revenue would be €36 million. If the company had set the price at €36,000 instead of €24,000 and still sold out the originally planned run of 800 units, revenue would have been €28.8 million. The difference between €28.8 million and €19.2 million is pure foregone profit. That means the company missed a profit opportunity of €9.6 million. The moral is that poor estimates of volume and/or price can cost a manufacturer a fortune.
It is equally problematic for luxury goods manufacturers to overestimate demand and thus to produce too many units. Such a precarious situation risks price erosion, especially on secondary markets. It is difficult to reconcile strict production limits with volatile demand. Manufacturers use certain approaches to strike a balance. One is bundling. De Beers has done that for years with diamonds. Customers are offered a mix of higher quality and lower quality diamonds at a set price. The customer must then make an all-or-nothing decision on the bundle. They cannot cherry-pick. Watchmakers take a similar approach. Let us assume that Model A is in high demand and Model B less so. The manufacturer has rigid production capacity for each model. One dealer orders 20 Model A watches, but does not want to buy any of Model B. The watchmaker offers ten units of Model A, but only on the condition that the dealer also buys five units of Model B. The prices are nonnegotiable. From the manufacturer’s perspective, this approach is understandable, but has a downside: the Model B watches will probably end up in secondary channels, where sales can jeopardize the consistent price levels the watchmaker works so hard to establish and protect. The ultimate cause of such price declines and inconsistencies is the miscalculation of supply and demand. This situation is very problematic for luxury goods manufacturers. First, price erosion can lead to massive frustration among customers who have paid full price. Second, these effects damage the brand image. Price stability, continuity, and consistency are indispensable for luxury goods. The myth of luxury goods is that they are everlasting and that is incompatible with price volatility. Ideally, prices for secondhand luxuries rise over time. Some customers therefore view luxury goods as investments. The prices of luxury goods usually reflect all performance attributes. Comprehensive service and other performance attributes (e.g., lifelong guarantees, club memberships) are built into the price. In other words, prices for luxury goods are usually “all inclusive.”
Distribution
A key aspect of distributing luxury goods is selectivity. Luxury goods companies often have only a small number of carefully chosen outlets or dealers per country. The watchmaker A. Lange & Söhne has only 25 dealers in the United States and 15 in Japan. In Germany, there are only four cities where you can purchase a Rolls-Royce. The exclusivity in the sales channel reflects the exclusivity of the product. This applies not only to the number of stores or outlets but also to a brand’s quality standards in terms of design and appearance of the sales floor, as well as the competence and discretion of the sales staff. To maintain these quality standards, manufacturers must exercise strict supervision and quality control.
The striving for high-quality standards and price enforcement have led luxury goods manufacturers to rely more and more on their own stores. Groups such as LVMH or Richemont already generate a large share of their business through their own stores. Luxury brands benefit more from their own retail stores and sales networks than from wholesale distribution. Although wholesale overall still accounts for 64% of sales of luxury brands, sales in retail (at current exchange rates) is growing more than twice as fast as sales in wholesale [50]. Revenue at the Italian luxury fashion group Prada shows a similar breakdown. The group currently generates 82% of its total revenues through its 613 self-managed stores [51]. Shifting to company-owned or company-managed stores is very important for companies which want to make the leap from premium to luxury. Luxury goods makers also use the agent model, under which, similar to the gas station business, the dealer acts as an agent representing the manufacturer. Under both systems, the manufacturer maintains complete control over all parameters, including price.
For a long time, luxury goods companies shunned the Internet as a sales channel. Personalized service and the shopping experience in an exclusive store seemed too important. Most companies have therefore limited themselves to the presentation of their products online. Only recently have some established online stores. The growth of online sellers such as net-a-porter.com or mytheresa.com has shown, however, that luxury goods buyers do make purchases online. The Internet and social media are becoming increasingly important for the luxury goods industry, even as brands wrestle with how to maintain the allure and exclusivity of “luxury” in a digital world. E-commerce in luxury grew to 9% of the market in 2017, more than doubling its share 5 years ago [50, 52].
Communication
Luxury goods require sophisticated and superior advertising, selective media usage, and collaboration with the best ad designers and photographers to maintain their brand image and convey their value to potential customers. Manufacturers often allocate up to a quarter of overall revenue to communication budgets. Public interest in luxury goods is generally high. Marketing makes strong efforts to reach out to customers through editorial content and background stories. The attractiveness of luxury products depends to a certain extent on their inaccessibility—while they are highly desirable to many, most people cannot afford or do not have access to them. The companies consciously cultivate this aspirational tension. Public relations and sponsoring therefore play a more prominent role than classical forms of advertising. The communication is often supported by spectacular actions or events.
Tradition is an important facet of a luxury good’s image and communication. A brand’s image is refined and solidified over time, and current advertising cannot replace a rich brand history. The Richemont and LVMH groups demonstrate the power of tradition in lending gravitas to their luxury brands. The average age of Richemont’s brands is 120 years, while those of LVMH are on average 110 years old. Classic may mean old, but not obsolete.
Price almost never appears in communications about luxury products, at least not explicitly. Rarely do luxury brands list price points in brochures, on homepages, or in stores. Prices are only available on request. This quasi-secrecy surrounding prices is a further signal that luxury goods are about pure value; price is not displayed as a point of interest. Implicit in this behavior is the idea that anyone who needs to ask for the price is not a “real” luxury goods customer. Charles Rolls, the founder of Rolls-Royce, put it this way: “If you have to ask what it costs, you cannot afford it” [53, p. 229].
Configuration of marketing instruments for luxury price positioning
Product | Price | Distribution | Communication |
|---|---|---|---|
• Extreme in quality and performance, especially on emotional and symbolic attributes • Comprehensive, personalized service • Highest exclusivity • Own manufacturing, often handmade or customized (very little outsourcing) | • Very high • Consistent across channels to retain value • No discounts whatsoever • Limited editions; price and volume planned concurrently | • Extremely selective distribution • Strict control of sales channels • Trend toward company stores or agent systems • Rather low but increasingly significant online sales | • Sophisticated advertising • Selective media usage • Heavy use of print (>60% of the ad budget) • Emphasis on PR, editorial content, reports, sponsoring, and special events • Emphasis on tradition • No active/explicit price communication |
2.6.1.3 Opportunities and Risks
Luxury goods markets are extraordinarily attractive because they combine high growth and high profitability. But conquering these markets is anything but easy. In the luxury sector, one finds primarily French, Italian, and Swiss firms. For luxury cars, the German and British brands are well represented. New players often struggle to establish the prestige and demand of true luxury brands.
Top performance on functional attributes is table stakes, but in and of itself not sufficient for success. The products must also deliver very high emotional and symbolic value.
In order for luxury goods to be profitable, they need to reach sufficient volumes—without producing such high quantities that they cheapen the brands. One risk is that the production volumes remain too small to be profitable (“curse of the small volumes”).
On the other hand, loss of exclusivity poses a threat. Luxury goods are by their very nature elitist. Exclusivity plays a key role. Growth strategies and expansion plans which dilute a brand’s exclusivity must be avoided. This applies to horizontal expansion into new product categories (brand extensions) as well as vertical extensions, i.e., down-market line extensions. Watering down the brand is extremely dangerous for luxury products. The expansion may pay off in the short run, but long term it can lead to the trivialization of the brand.
More and more, luxury goods makers are opening their own stores in order to maintain control over prices and the quality of the sales experience. This opens up growth opportunities but requires a massive capital investment and the assumption of additional risk.
2.6.2 Premium Price Position
2.6.2.1 Basics
A premium price position means that a product or service is offered at a price which is noticeably and sustainably above the market average. There are premium products and services in almost every sector. On the consumer side, these include Mercedes-Benz and Lexus (cars), Miele (washing machines), Nespresso (coffee), Starbucks (coffee shops), Clinique (cosmetics), and Apple (consumer electronics and computers). Premium services include Singapore Airlines and Lufthansa, private banks, and hotel chains such as InterContinental and Four Seasons.
But premium products are by no means limited to prestigious consumer products. There are also many premium offerings in B2B industries. We often hear the expression “We are the Mercedes-Benz of our industry” in connection with industrial goods. Midsized world market leaders, the so-called Hidden Champions, usually have a price level of 10–15% above the market average and still rank as global market leaders [54].
For a premium price position, the quality, competence, or uniqueness of the supplier is at the forefront of the customer’s interest. Price is not. The cost differences between competing offers are typically smaller than the differences in the perceived value and the resulting willingness to pay. The latter is systematically exploited through the premium price. A board member of a premium automotive company explained the premium position: “Our prices should be 12–16% above the market average, but our costs should only be 6–8% higher. This difference is where the music plays.”
Price difference between market average and premium prices, Status: January 2018
Product | Medium-price position | Premium-price position |
|---|---|---|
Chocolate (3.5 oz) | Cadbury: $1.93 | Scharffen Berger: $4.99 (+159%) |
Ice cream (35 oz) | Breyers: $2.18 | Ben & Jerry’s: $8.68 (+298%) |
Pencils (each) | General’s Kimberly Graphite Pencil: $0.95 | Faber-Castell 9000 Pencil: $2 (+110%) |
Men’s dress shirt (white) | Alfani: $52.50 | Hugo Boss: $95 (+81%) |
Smartphone | Huawei P10 (64 GB): $449 | iPhone X (64 GB): $999 (+123%) |
HDTV (55 in.) | Toshiba: $449.99 | Samsung: $1099.99 (+144%) |
Midsized car (base model) | VW Passat: $22,995 | Mercedes-Benz E-Class: $52,950 (+130%) |
Hotel, Miami (one night, classic room) | Hilton Miami South Beach: $217 | Four Seasons $478 (+120%) |
Premium products are not only superior in terms of functional performance; they should perform strongly across emotional, symbolic, and ethical attributes as well. They are characterized by high quality and an outstanding service package. Innovation is often the basis for their superiority. The high price itself can become a positive attribute. This effect can come from price serving as an indicator of quality as well as from the social signals (Snob or Veblen effect) it sends. Through the purchase and use of a premium product, customers consciously separate themselves from the crowd, but without fully removing themselves from mainstream society (as might happen with luxury goods).
2.6.2.2 Management
Product
Given the quality expectations, the product itself plays a central role in premium price positioning. Superior competencies along the entire value chain are indispensable, from innovation to the procurement of raw materials. It also covers stable production processes and above-average capabilities of the sales and service organizations. In no other product category—not even for luxury goods—is innovation more important than for premium products. This is because the unique selling proposition (USP) of premium products is often first established through innovation.
In the smartphone industry, groundbreaking innovations (front camera, retina display, HD camera with optical zoom, stereo speakers, 3-D touch) are generally introduced in premium models (such as the iPhone) and then spread to the average and lower price ranges. As a result, the competitive advantage derived from any given innovation is only temporary, so premium suppliers face constant pressure to innovate. Some brands stress this emphasis on constant innovation in their advertising claim. The premium household appliance manufacturer Miele has used the slogan “forever better” since its founding in 1899. This slogan represents the firm’s guiding philosophy. Miele has always strived to be better than its competitors and continually improves its products.
Nonetheless, innovation isn’t the only successful premium strategy—a company can also focus on remaining true to what has worked well. One calls this variant the “semper idem” (always the same) strategy. “Semper idem” is actually the motto of Underberg, a digestive famous in German-speaking countries. The USP of such products, such as Chivas Regal, derives from the fact that the product never changes. Constancy is an advantage. But this applies only to the product itself. The company has to adjust and adapt its marketing methods and its production processes. Premium products also require a level of service which is both comprehensive and of a similar quality as the product itself. To deliver this, companies require highly qualified employees both internally and at its sales and distribution partners.
Price
The comparatively high price is an integral feature of a premium product. The price cannot become a ping-pong ball for discount actions, special offers, or similar price-driven measures. Premium suppliers must place a high value on continuity, price discipline, and price maintenance. Wendelin Wiedeking, the former CEO of Porsche, explains: “Our policy is to keep our prices stable, in order to protect our brand and avoid a decline in the residual value for used Porsches. If demand falls, we cut our production, not our prices.” The current marketing decision-makers at Porsche, Bernhard Meier and Kjell Gruner, have a clear philosophy on this point: “We always want to sell one vehicle fewer than the market can absorb, in order to remain true to our brand promise of high exclusivity and high retained value. We are not volume driven, but rather obligated to an enduring business” [55].
Sharp variations in price are not compatible with the sustained high-value image of a premium product.
Temporary price reductions will frustrate or anger customers who purchased the product at its normal (high) price.
For durable goods, price actions can jeopardize prices for used products. The residual value is an important purchase criterion for these kinds of products. A decline in residual value can diminish willingness to pay for new products.
Recommended prices for resellers are appropriate for premium products and should be enforced. The manufacturers of premium products should be resolute in preventing the use of their products as loss leaders, even though this may not be easy to achieve for legal reasons. Retailers and resellers continually try to circumvent the efforts of manufacturers to maintain resale price discipline.
Above all, manufacturers should resist the temptation to lower their prices. It could certainly be the case that the price elasticity for a premium product is very high when the price cut is massive, leading to a sharp rise in sales volume. After repeated use of this tactic, however, the product could lose its premium status and become a mass-market product. An example of this is the clothing brand Lacoste. The French professional tennis player René Lacoste founded the company in 1933 to sell sports shirts he designed. The recognizable crocodile emblem stood for exclusive prestige, and the Lacoste shirts achieved high prices and margins. US President Dwight Eisenhower and other celebrities wore Lacoste shirts in public. For 50 years, Lacoste was a brand associated with high social class. Over time, though, Lacoste became a mass product. The prices fell. As a consequence, sales volume declined, triggering more price reductions and ultimately lower profits. This case sheds light on why price discipline for premium products is so important.
Distribution
Premium product distribution rests on exclusivity and selectivity, beginning with control over how the product is presented. This goes beyond the visual presentation to include the qualifications and appearance of sales personnel. Implementing this maxim in practice often proves difficult. In industries such as clothing or consumer electronics, it is not uncommon for premium products to be sold in an environment dominated by medium or even low-priced products, even though that is unlikely to be in the best interests of the premium manufacturers. Increasingly, premium suppliers are setting up stand-alone “shop-in-shop” spaces within department stores to separate their products from the medium-priced ones. This concept has proven itself and is fitting for a premium price position.
According to Lasslop [56], one should split the distribution hierarchy for premium products into three levels. At the highest level are the flagship stores, whose primary purpose is to “celebrate and worship” the premium brand. Examples of such stores are those of Apple, Nike, or the coffee brand Nespresso. Achieving high revenue is not the main purpose of these stores. Rather, they showcase the brand, as the term “flagship” implies. They should create a destination for consumers to immerse themselves in the brand and its aspirational, premium nature. The second level is franchised stand-alone stores in which the manufacturer still maintains control overall key parameters. The third level of the distribution hierarchy is comprised of specialty retailers and upscale stores, such as Nespresso boutiques in Sur La Table or Macy’s in the United States. The trend toward the “shop-in-shop” has taken hold in particular in upscale stores. Because of the demands placed on these intermediaries, their selection follows very strict criteria. In exchange for complying with the manufacturer’s demands for a high-quality presentation of the product, a sophisticated ambience, and highly qualified personnel, the selected intermediary receives a certain level of territorial exclusivity. In some cases, the manufacturer adopts an exclusive distribution system.
The distribution of premium products through a national network of factory outlet centers (FOCs) should be viewed critically. True stand-alone factory sales stores, which operate only locally, expose the image and price of premium products to less risk. In sectors where customers don’t tend to have strong loyalties to a retailer (e.g., textiles, furniture, and household appliances), factory outlet centers can be an interesting distribution option. These centers tip the balance of power in retail, which often favors the store, slightly in favor of the manufacturer. Manufacturers prefer to offer goods from the previous season at FOCs rather than the latest models.
While the luxury price segment still has a limited online sales presence, due to its inaccessibility and exclusivity, the premium segment is increasingly using alternative distribution channels. Online sales now account for around 17% of the revenue for premium brands [57]. When they buy premium products or premium brands, customers still expect outstanding service, customer orientation, and customer care [58], which are prerequisites for a high willingness to pay in this segment. But these service aspects are often very hard to fulfill online. Thus, the opportunities for success in online distribution channels depend on the sector and on how explanation-intensive the product is. For example, consumers are rather willing to purchase an iPhone upgrade online than a new washing machine or furniture.
Communication
Due to the relevance of branding for premium products, it goes without saying that communication is very important. The content of the communication focuses primarily on exclusivity, prestige, and continuity. In addition to classical advertising, premium products are increasingly relying on “below-the-line” activities. These include public relations, event marketing, and product placement. James Bond drives a BMW 750iL in “Tomorrow Never Dies.” BMW marketed the launch of its i8 hybrid electric vehicle in conjunction with the Mission Impossible film “Ghost Protocol” by having Tom Cruise drive the car. The slogan “Mission to drive” connects the reputation of the film to the automobile. Apple products also appear prominently in many films.
The communication of premium products derives from performance, emotion, and social prestige. Price stays in the background. If a company succeeds in establishing a premium image, the price plays a secondary role in the purchase decision.
Configuration of marketing instruments for premium price positioning
Product | Price | Distribution | Communication |
|---|---|---|---|
• Outstanding functional performance and quality • Comprehensive service package • High importance of emotional, symbolic, and ethical attributes | • Sustaining a high relative price • Uncompromising on discounts and promotions • Price discipline and maintenance are particularly important • Clearance sales only for fashion products | • High exclusivity and selectivity • Establishing control over the presentation of the product; high demands placed on the seller/retailer • Selective, but increasing level of online sales | • Emphasizes non-price factors • Continuity of the message • Use of below-the-line activities (e.g., product placement) |
2.6.2.3 Opportunities and Risks
Relatively low-price elasticities in the upper price ranges allow for higher premiums.
Because customers in the premium segment place higher value on performance attributes, there are more opportunities for product differentiation than in mass markets. Every performance attribute is a potential competitive advantage. Canoy and Peitz [60, p. 307] assess these opportunities from the customer perspective: “Customers’ evaluations are more dispersed in the high-quality range than in the low-quality range.”
The frequency and the danger of price wars are lower in the premium segment than in the lower price ranges. A “price warrior” in this segment risks ruining its brand image.
Rising wealth and rising incomes are driving growth in the premium segment. Customers are trading up from the medium segment to the premium segment.
Financial crises can cause shifts in demand from the luxury segment to the premium segment.
A greater emotional awareness among customers can be observed. The demographic transformation—or more specifically, the aging of society—leans in that direction. According to an Accenture-GfK study, many older consumers prefer expensive products and sales channels [61].
A particular challenge lies in achieving and maintaining a high level of quality and innovation. A purely image-based differentiation will not endure if the product or service does not deliver the quality to back it up. Quelch [62, p. 45] states: “Mere exclusivity without quality leadership is a recipe for failure.”
The brand faces similar risks. If a company fails to position or maintain its brand at the level that premium customers expect, it is headed for trouble. The VW Phaeton could serve as the poster child for this. The VW brand proved too weak in competing against BMW or Mercedes in the premium segment.
Products upgraded from medium pricing also pose risks to existing premium products. If the aspiring company improves both the product’s quality and its image, that product can attack premium products from below. Such trade-ups occur in many markets. Toyota’s Lexus is a telling example.
Managers of premium products must resist the “temptation of large volumes” and the growth they promise. One of the most effective and quickest ways to destroy a premium price position is to cut prices in order to reach the mass market, i.e., to hit higher volume numbers and achieve wider distribution.
For consumer durables, the secondhand market can pose risks. Premium products enjoy a high level of popularity on secondhand markets. The Internet has aggravated this problem. This is well-known in the market for cars. A flourishing secondary market can suppress demand for new products and exert downward pressure on the prices for new products. Premium manufacturers should keep a close eye on the secondary market and intervene if necessary.
The premium position implies higher complexity and higher costs. A high level of performance does not come at low costs. Thus, there is the risk that costs get out of control. For premium products, one must always make sure that higher prices overcompensate for additional costs. Costs which do not contribute to an increase in customers’ willingness to pay should be avoided.
2.6.3 Medium-Price Position
2.6.3.1 Basics
A medium-price position means that from the customers’ point of view, a product or service has a middling level of performance and a consistently midrange price, relative to the market average. A medium price falls within the customers’ perceived market average. The same applies to the level of performance. Products with a medium-price position typically include classic branded products which have often helped to set standards in their respective markets. Examples include Buick, the household goods manufacturer Whirlpool, or retailers such as Kroger and Tesco. Products and brands in the medium-price range have been and remain very significant. Characteristic aspects comprise brand, the promise of quality, image, becoming synonymous with an entire category (Kleenex, Q-Tip), and ubiquity.
As discounters penetrate further into markets, the medium-price position has come under attack, but in the recent past, there has been a countertrend—the medium-price position is getting stronger again. In terms of overall volume and value, the medium-price range still forms the largest segment in many markets. Brands such as Gap or American Eagle achieved success with a medium-price position. Importantly, their level of quality distinguishes medium-priced retailers from low-priced competitors such as H&M, Forever 21, or Primark, combined with current, up-to-date designs. The medium-priced retailers do not offer top cuts or materials such as Hugo Boss or Ralph Lauren do, and the symbolic performance does not stand out as much, but the price is also noticeably lower than for premium products. Within fast-moving consumer goods, there are numerous product categories in which the medium-price position is dominant. Some 60% of the market for noodles falls in the medium-price range [63].
2.6.3.2 Management
Product
Good and constant quality is the predominant characteristic of medium-priced products. In comparison to low-priced products, a supplier should pay attention to establishing customer preferences based on performance. This affects primarily the components of the functional attributes, such as technology, the degree of innovation, and reliability or durability. Medium-priced products should also differentiate themselves in terms of packaging and design (emotional performance) as well as at a rudimentary level along symbolic attributes. This applies above all to consumer products. The management of the brand therefore is highly important. While medium-priced products are less differentiated than premium products, they offer more variants and models than low-priced products.
If variable unit costs fall due to scale and experience curve effects, the company needs to decide whether to reduce prices or improve performance. In many cases, the company with a medium-price position opts for improved performance in such a situation, whereas a manufacturer of low-priced products would react by lowering the price. This is done in order to further expand the competitive advantage of “superior performance.” For this reason, prices in the medium-priced segment of the computer industry generally do not fall but instead offer more performance and more accessories from generation to generation for the same price. A committed low-priced supplier would instead tend to cut prices in order to reinforce the “low-price” competitive advantage.
Price
Consistent with the brand image and stable quality, many suppliers of medium-priced products try to maintain a steady price level as much as possible. They are trying to keep price competition at the retail level in check. In order to stem the frequency and the extent of special offers or discounts, medium-priced suppliers practice active price maintenance. The goal is to harmonize end consumer prices within a certain range (price corridor). Because vertical price-fixing is forbidden, it is not possible to steer end consumer prices directly when the products are sold through distributors or retailers. Nonetheless, the manufacturers definitely exert some influence over end-customer prices. The associated measures include identifying loss leaders, tracking the flow of goods in order to prevent gray imports, buying up reduced price goods, appealing to the trade partners, limiting on deliveries, or incentivizing channel partners to maintain and enforce recommended prices. Legally, this is a gray area in which the power of the manufacturer has been declining.
Special offers play a bigger role for medium-priced products than they do for low-priced ones. First, the wider price spans across competitors give a company more leeway to make temporary price reductions. Second, the effects of special offers or price promotions on sales volumes are typically strong. A volume increase of five to ten times normal sales can occur during promotional periods. Special offers are also employed to win back customers who have switched to bargain or low-priced products. But one must be careful not to use such price tactics too frequently, run promotions for too long, or offer a reduced price that is too far below the normal price level. When one fails to follow these maxims, the customers get accustomed to the lower prices and start to buy only when they see them. This erodes the brand image. Banana Republic, Ann Taylor, and J. Crew have all fallen into this trap, offering as many as 18–20 promotion days per month in recent years to keep their sales volumes consistent. In reality, the position slips into the low-price category, but without being armed with the corresponding low-cost structures.
Price differentiation according to different package sizes or feature sets is important for medium-priced products. While bargain products are often only available in fixed configurations, customers in the medium-priced segment have many options to choose from. In contrast to the discounter stores, the assortment in medium-priced stores tends to be broader and show greater price differentiation. Of course, the customer also expects competent advice, better service, and more goodwill than they would from low-priced products. This creates opportunities for tactics such as price bundling or charging for certain services separately (unbundling).
Distribution
A classic characteristic of medium-priced branded products is their ubiquity, but we observe some differentiation in distribution channels. Some discounters only offer limited quantities of branded products, if they offer them at all. Nonetheless, medium-priced products enjoy the larger sales reach. They are sold through many channels and by many intermediaries. That holds true even in new sectors.
In harmony with the quality claim of medium-priced branded products, manufacturers must exercise quality control over the sales channels. This is especially important for products which may create liability risks or require extensive consultation. These are areas where the specialty trade still dominates. The more important the performance of the reseller is, the greater the markups in the respective channel. Here we need to distinguish between push and pull products. A “push” situation occurs when the reseller serves the customer and can recommend the product, such as when someone buys an over-the-counter medication at a drugstore. In such cases, the reseller often has a decisive influence over which product the customer buys. And the reseller wants appropriate compensation for this service. In a “pull” situation the customers determine on their own which product to buy. Self-service is a good example. The manufacturer must then use its advertising in order to ensure that an end customer has a sufficiently strong preference for its brand. The reseller fulfills only a logistical role in this case.
Online sales are becoming increasingly important for medium-priced products. Many well-known brands use the Internet and online shops for direct sales or sales through third parties. But the use of online sales varies significantly by sector. The food and grocery industry has not made much use of this channel so far, but the emergence in the United States of Instacart, Amazon Fresh, and Google Express alongside older forms such as PeaPod shows this may be changing. Nowadays, though, it is hard to imagine software, electronics, or travel industries without the online channel. Customers use the Internet for research as well as for price comparisons. It is also normal to purchase electronic devices or shoes online. The digital competition is putting the survival of many brick-and-mortar stores at risk, as they have difficulties in keeping up with what the online stores offer. Mainstream music and video stores have been almost extinguished entirely by online channels such as the streaming services Spotify and Netflix.
Communication
For the medium-price position, communication plays a different and more important role than for low-priced products. There are many reasons for this. First, performance and quality advantages across many dimensions demand more intensive communication than the one-dimensional price advantage does. Second, brand recognition and brand image—created largely through communication—have a greater significance. Medium-price suppliers therefore invest a lot more in communication than low-price suppliers. In order to reach a broad target audience, they mainly use mass media (television, popular magazines, etc.). Increasingly the Internet is serving as a supplementary communications medium to TV. This holds true in particular for younger target groups with a high Internet affinity. That is how digital, cloud-based services often market themselves, predominantly through advertising and banners. Such firms include Spotify, Amazon, and online boutiques. Online communication in this regard is no longer limited to banner ads or video clips; it is largely driven through the use of social media and branded content instead of traditional advertising. It is customary for medium-priced brands to use Facebook, Twitter, Instagram, or Pinterest to communicate with fans and followers directly.
In terms of advertising content and design, the performance and quality matter most. The price itself is rarely an object of communication, and when it is, it’s usually in terms of the price-value relationship. Depending on the product group, the advertising often emphasizes an emotional component. Companies attempt to associate the product with feelings and experiences which foster a connection to the product and create willingness to pay. One peculiar aspect of medium-priced products is their socially neutral image. Low-priced products, in contrast, tend to be associated with a lower social status. Premium and especially luxury products confer a higher level of social prestige. Of course it goes without saying that these effects influence willingness to pay.
Configuration of the marketing instruments for medium-price positioning
Product | Price | Distribution | Communication |
|---|---|---|---|
• Good functional performance • Continuous performance improvement • Emotionally charged; occasionally symbolic and ethical • Many variants • Brand is very important | • Consistent prices, but functional improvement from version to version • Monitoring and maintenance • Use of special offers • Price differentiation based on moderate/slight performance differences • Opportunities for complex price structures (bundling and unbundling) | • Ubiquity • Many sales channels • Online sales are significant • Some quality control over the channels • Specialty trade (for products requiring extensive explanation) | • Relatively high investment • Relatively high share of classical advertising (mass media such as TV and print) • Emphasis on performance and quality, not on price • Social neutrality • Increasing use of online sales and social media |
2.6.3.3 Opportunities and Risks
Classic branded products in the medium-price range are not only well-known but also positively charged. They are associated with attributes such as fair, honest/genuine, and reliable.
They avoid in equal measure being “cheap” or “pretentious.” This aversion to extremes helps medium-priced products. They are not as polarizing as products in the upper or lower ends of the price scale.
Medium-priced products minimize search costs and perceived risks for consumers. When customers are not well-informed about a product, they often opt for something from the medium-price range. Hayward [64, p. 66] remarks: “Consumers are seeking options that perform satisfactorily, are simple and easy to understand and find, require little research to select, carry little risk either emotionally or economically, and are reliable and trustworthy.”
On the other hand, the medium position can contribute to the lack of a well-defined profile. “They are significantly more expensive than the lower-priced products, but not as good as the premium products—a lousy compromise” captures the essence of what consumers might think.
The medium-price range is subject to attacks from above and below. From above, premium competitors may want to carve out their own piece of the medium segment. From below, low-priced competitors attack with products whose quality continues to improve. In food and grocery, the discounters are attacking the midrange retailers with improved selections at consistently lower prices.
Companies also face internal risks. Cost pressures can lead a company to reduce its traditional performance advantage or give it up entirely. This so-called “salami-slicing” tactic might escape the customers’ notice in the short term, but long term, it can destroy a medium-price position. In order to avoid this, one must understand very precisely what attributes or performance levels are indispensable for customers and for which they are willing to pay a bit more.
Medium-priced products often have a long tradition. Thus, they face the risk that they appear old-fashioned as their core consumers age. They may lose their attractiveness to younger buyers. One must work directly and resolutely against this trend and keep the image up to date. Using discounts to compensate for an outdated image is ineffective.
It is controversial as to whether “the middle” is getting weaker or stronger. On the one hand, the polarization of markets poses a serious challenge to the medium-price position. On the other hand, one would think there will always be a market for offering a reasonable level of performance at a fair price. Some studies show that the middle is getting stronger, while others reveal the opposite. Low-priced and premium-priced products are both moving toward the middle. The low-priced suppliers do this by continually improving their quality, while the premium suppliers try to offer slimmed-down or scaled-back versions of their products at more favorable prices. Both trends are apparent, depending on the market. The medium-price position is also not necessarily a “stuck in the middle” with poor returns. Cronshaw et al. [65, p. 25] have found that medium-priced companies perform better than low-priced ones. Sharp and Dawes [66, p. 749] note that many medium-priced companies and brands have shown sustained, above-average success. One could mention examples here such as Toyota (automobiles), LG (electronics), Dove (cosmetics), Best Western (hotels), Pepsi (beverages and snacks), and Kellogg (breakfast foods).
2.6.4 Low-Price Position
2.6.4.1 Basics
A low-price position means that relative to the market average, a company offers a lower level of performance at a sustained lower price. The low-price positioning has grown in importance over the last few decades. Among Germany’s food and grocery retailers, discounters have been able to grow their market share to around 45%. The hard discounters ALDI and LIDL are penetrating other countries successfully, including the United Kingdom and the United States. Low-price companies have penetrated other sectors as well. They include electronics (Best Buy, Dell), clothing (Forever 21, Primark, H&M), beer (Keystone), motels (Motel 6, Red Roof Inn, Microtel), or furniture (IKEA). In air transportation, there are many inexpensive alternatives nowadays (Southwest Airlines, Ryanair, EasyJet), just as there are in car rental (Enterprise, Budget).
The same applies to banks which take advantage of the Internet and pass the cost advantages on to their customers. They include Bank of Internet USA and Capital One 360. Even in sectors where intensive pre-purchase consultation is required, low-priced suppliers have established market-leading positions. One example is prescription eyewear, where Fielmann is the European market leader. Fielmann’s prices are significantly lower than those of traditional eyewear retailers. In the United States, Costco offers low-priced eyeglasses and contact lenses through its own Costco Optical department, whereas Warby Parker primarily sells eyeglasses online.
A special low-priced segment which has shown strong growth is the factory outlet center (FOC). These centers offer an additional sales channel for branded products and are predominantly used by clothing and fashion companies. True to the name, companies market unsold branded merchandise at marked down prices at these outlets. In some cases, retailers create outlet-specific lines with lower quality and lower cost but still branded. The FOC removes the retailer markup and cuts shipping costs. These savings are passed on to consumers in the form of lower prices. This is similar to the method carmakers use when they sell vehicles to their employees, car rental companies, or other fleet operators at reduced prices. For some car brands, almost half of the volume goes through this “second price track,” which brings weaker margins.
Companies with low-price positions have been broadly successful in seizing large market shares. But the results are mixed when we look at their profitability. The majority of low-priced companies do not survive over the long term. The German home improvement chain Praktiker AG, which used the slogan “20% off everything” for years, ultimately shut its doors. When these companies survive over the long haul, though, they often have both growth rates and returns which are significantly above those of comparable companies with higher price positions. Such companies include ALDI, IKEA, Ryanair, and Southwest Airlines. The market capitalization of Ryanair, at around $23 billion, is higher than that of Lufthansa at around $15 billion. Price transparency, which the Internet has amplified, and the trend toward keeping the basic service as low-priced as possible have combined to increase price sensitivity and lure new customers to these companies.
These successful examples show that a low-price strategy only makes sense when it is based on a low-cost position: “There is no such thing as a low price strategy. The only way to win is to have lower costs than your competition” [37, p. 13]. A low price on its own will not lead to success unless the company also keeps its costs low. The principles of a low-cost strategy come into play even for complex products, such as investment funds. A comparison of the investment firms Fidelity and Vanguard illustrates this. While Fidelity focuses on active portfolio management, Vanguard offers lower-cost investments in index funds (ETFs). This is how Vanguard succeeds in maintaining the lowest costs in the industry [66].
2.6.4.2 Management
In the spirit of Michael Porter, a low-price position is tightly linked to cost leadership [67, pp. 11–22]. In order to survive long term with low prices and generate adequate returns, companies must have sustainable cost advantages. They need to exploit the economies of scale and the experience curve. Constant monitoring and the minimization of costs along the entire value chain are indispensable for low-price positioning. Product/service simplification is closely tied to cost leadership. This simplification requires limiting product and service offerings to the essentials—aiming for the most basic level of functional performance which sufficiently satisfies the customers’ needs. Low-cost sellers shy away from offering anything in excess of that. They avoid over-delivering on functional attributes and refrain from addressing additional emotional, symbolic, or ethical needs, especially when doing so would result in additional costs or complexity.
Product
The demands of cost leadership imply that a company needs to offer standardized products and services. Economies of scale and experience curve effects only take hold at large volumes. The costs of unnecessary complexity must be avoided. Therefore, low-price companies place strict limits on their assortments. For example, ALDI stocks only 57 types of juice, while the classic supermarket would have 165 juice varieties on the shelves. A classic supermarket would offer 223 different coffee products; ALDI offers 49.
This has a massive effect on inventory turnover. ALDI turns its capital over 2.6 times per year, whereas a supermarket achieves about one time [68]. In order to offer a relatively large number of end-product variants despite a small number of base modules or versions, some companies turn to a so-called platform strategy. Different variants result from the combination of standardized modules. This approach is widespread in the automotive industry, in computers, and increasingly in heavy equipment and engineering.
Product simplification, however, remains the most important factor in saving costs. It is always a question of “what level of performance adequately solves the customer’s problem?” The mobile telecom company Congstar (“you want it, you got it”) offers no service. It does not subsidize phone purchases, provide 24 h service, or even have any physical stores. All it does is sell prepaid phone cards (with no extras) online. In other words, what Congstar offers is rudimentary and purely functional.
In a similar way, low-cost airlines leave out many of the services passengers came to expect from classic airlines. The low-cost competitors usually do not offer seat reservations, lounges, status cards, programs, or magazines. When they offer food and drink or checked baggage, they collect a surcharge. In 2006, Ryanair pioneered carving out the previously sacrosanct passenger baggage allowances and started charging separately for them. Other airlines followed suit.
As part of its aggressive price repositioning, HanseMerkur Insurance drastically simplified its product and service portfolio. By offering entry-level rates for policies which eliminated everything (e.g., ambulant psychotherapy) which does not involve an existential risk, the company successfully established itself in the low-price segment of the health insurance market. The simplification of its offering not only spares the customers from high insurance premiums; it also boosts the insurance group’s income from premiums [69]. A strong focus on functional performance is typical for low-price resellers.
The principle of simplified performance also manifests itself in a company’s branding. A low-priced position is often seen as synonymous with “no name” brands, “me too” products, or store brands. Building up a strong product brand requires high investment and is incompatible with cost leadership. Minimal or basic branding goes hand in hand with sensible packaging. Products which have a limited range of options but whose quality is highly transparent (such as basic foodstuffs) lend themselves well to low-price positioning. In addition, such products should be more or less self-explanatory, rather than require extensive consultation or an in-depth sales pitch.
Price
The USP (unique selling proposition) and the competitive advantage of the low-price position is the price itself. In retail this translates into the prevailing practice of “every day low prices” (EDLP). All other marketing instruments are aligned with the goal of maintaining and supporting the low price. Using a “Hi-lo” approach—i.e., offering temporary low prices on a recurring basis—is atypical for low-price suppliers. IKEA provides a success case. For years, the Swedish furniture maker has mastered the challenge of achieving high product volumes at consistently low prices across diverse markets, languages, and cultures. The IKEA model is based on the volume of the assortments and the production of the exact same products, year after year. This helps IKEA lock in low prices from its suppliers and pass some of these savings on to consumers. The more stores IKEA opens, the more volume it can generate. That means that IKEA can implement further price reductions. Another important aspect of IKEA’s price strategy is the selection of so-called breathtaking items. These iconic, very familiar products with very low prices (such as Billy shelves) exert a halo effect on the entire assortment [70].
In order to maintain an attractive price image, it can be advantageous to cut prices on a regular basis. Low-priced suppliers are usually quick to pass cost savings on to their customers. This is not necessarily driven by altruism, but rather by the goal of preventing competitors from undercutting them on price. “At the end of the day, ALDI needs to re-establish its good reputation over and over by making fresh price cuts,” said one expert [71]. ALDI’s corporate philosophy is expressed as follows: “Every aspect of our operations has been rethought and reinvented to maximize the quality of our products and savings for our customers.” The German website is more specific: “Whenever we have the opportunity, such as when commodity prices decline, we pass on those savings to our customers and lower our retail prices right away” [72]. When raw materials costs rise, however, even the discounters cannot avoid price increases. When configuring a price or conditions structure, simplicity rules. Complicated price structures require too much time-consuming explanation. Such factors include payment terms and discounts.
Distribution
Sales management contributes to cost leadership by using efficient distribution structures and a limited number of channels. Online sales play a very important role for low-cost suppliers, especially in the service sector. Tickets from low-cost airlines are available online or by telephone, but not through travel agents. Dell sells almost all of its computers directly to end customers. Such distribution channels do not require a large sales force. In the physical trade, low-cost suppliers look for less expensive locations which are easily accessible by car. Nonetheless, even discounters have begun to follow a trend toward more expensive locations in city centers. The overarching focus on simplicity extends not only to store locations but to the rather spartan appearance of the stores themselves and to the standardization of internal processes. For example, it is advantageous to always place the same product at the same location in the store, often on palettes or in the original shipping cartons.
Communication
The communication of low-priced suppliers faces contradictory demands. On the one hand, low prices do not leave room for large advertising budgets. Strict control and minimization of communication costs are imperative. At the same time, the company needs to effectively communicate the low prices to their target audience in order to achieve the correspondingly high volumes and market shares.
Some low-priced suppliers forgo advertising entirely and rely instead on the pull of the distribution channels they use. When they do advertise, it is primarily done to communicate the price advantage and done through inexpensive media. For example, Europe’s leader in prescription eyewear, Fielmann, relies on radio and newspaper ads. The advertising budgets of low-priced companies are usually below the industry average. Nonetheless, companies –especially retailers—sometimes wage fierce communications battle for the “low-price” mantle. Walmart and Best Buy come to mind in this regard.
An additional tactic of the low-price suppliers is the use of spectacular actions or provocative statements, in the hope of garnering wide media exposure. That is free advertising. Michael O’Leary, the CEO of Ryanair, is famous for such actions. These include, for example, his announcement that Ryanair may start charging passengers to use the bathroom in flight (something the company never actually implemented). Ryanair even wants to offer price comparisons for all airlines on its own homepage. With his characteristic cockiness, O’Leary proclaimed that Ryanair would “always be the cheapest anyway” [73].
Successful low-price positioning is about using aggressive advertising to convince as many customers as possible with the low-price argument. Once the low-price image is anchored firmly in the customers’ minds, the company can perhaps scale back its ad spend. The Internet is a particularly good fit for communicating a low-price position. Price comparison sites reach a large audience and favor the low-priced suppliers.
The price is the central message and selling argument number one for a low-price position. Other performance aspects are relegated to the background. Price advertising tends to be very aggressive. In print media, the price often appears larger than the product itself. In radio and television, the ads hammer home the same, price-based slogan over and over again.
Configuration of the marketing instruments for a low-price positioning
Product | Price | Distribution | Communication |
|---|---|---|---|
• Focus on essential functional attributes (core performance) • Low emotional, symbolic, and/or ethical performance • Limited assortment | • Sustained low prices (EDLP) • Few special offers • No complex price systems • No discounts | • Hardly any product support services • Limited sales channels • Inexpensive locations and sales methods • Very high importance of online sales | • Emphasis on price (price advertising) • Limited, affordable media • Simple slogans which run for a long time |
2.6.4.3 Opportunities and Risks
The low-price segment must be sufficiently large. This applies not only to the willingness to pay but also to the acceptance of less value. The low-price segment can draw demand from above (decline in social status), from below (increasing incomes, which applies in particular to emerging countries), or by tapping into latent demand (“products are getting more affordable”). All three pools of demand play a role. Stagnating real incomes are causing some consumers to trade down to less expensive products. In emerging markets, in contrast, many consumers are now earning enough money to afford low-priced products for the first time. The radical low prices of the budget airlines opened up new layers of demand for air travel.
Low-priced suppliers need to achieve and maintain significantly lower costs. These cost advantages can be achieved through new business models (e.g., IKEA, Dell, Ryanair, Amazon) and/or scale advantages, which result from high volumes or high capacity utilization. But this means that in most markets only a small number of bargain suppliers can survive and succeed over the long term.
Quality still must be acceptable for a sufficiently large number of customers. Low-price suppliers don’t succeed because they are “cheaper” but because they combine low prices with acceptable (but not high!) quality. ALDI is a prominent example for this strategy. Its consistent quality is an important reason why customers who have traditionally shopped in higher price ranges increasingly find ALDI’s low-price offers acceptable.
Traditionally higher-priced manufacturers face structural barriers which make it very difficult for them to respond to the market entry of low-price competitors. These structural constraints can be existing price contracts, investments they have made, locations, technology, or corporate culture.
Low-price suppliers require special marketing competencies. They need to understand precisely what they can remove from their offerings—in terms of performance and cost savings—without doing much harm to the customers’ perceived value. It is a misconception that marketing for a low-price positioning is easy. In fact, the opposite is true.
Despite their low costs, low-priced suppliers are still dependent on a mix of businesses. That means that they need a certain number of customers who are willing to pay a bit more for some products in the assortment. That applies to bargain airlines, who charge more for late or last-minute bookings and for business travelers. It also applies to retail. Fielmann, for example, offers its basic models at very affordable prices, but it also sells more expensive eyewear and does offer a wide range of additional features (e.g., special lenses, anti-reflection, insurance) for which the customer pays extra.
Low-priced companies face considerable risks. The biggest one is that their costs get out of control. This can happen when the company’s cost consciousness weakens (perhaps they want to become a more sophisticated or finer supplier) or if certain cost drivers get out of control. When fuel costs spike, bargain airlines are affected disproportionately relative to traditional airlines, because fuel makes up a larger share of their costs. Many Chinese competitors have suffered from wage increases which they could not pass on to their customers, because their market positions and their brands were too weak. The social milieu can also be a risk factor. If the core customers or the locations of a low-priced supplier fall down the social ladder, it can turn off the customers at the higher end of the price range. If that happens, the low-cost supplier cannot make the math work anymore.
2.6.5 Ultra-Low Price Position
2.6.5.1 Basics
An ultra-low price positioning represents a radically minimalist product offered at an extremely low price. In the developed, industrialized countries, the low-price segment we described in the previous section forms the low end of the price scale. In emerging markets, an entirely new segment has come into existence over the last several years. Prices in this ultra-low price segment are sometimes up to 50% below those in the low-priced segment.
Two Indian-American professors called out the emergence of this new segment years ago. With his book “The Fortune at the Bottom of the Pyramid,” the late C.K. Prahalad, a strategy expert, was the first to point out the opportunities in the rapidly growing bottom price segments in emerging countries [75]. The steady growth in China, India, and comparable countries means that every year, many millions of consumers gain sufficient purchasing power to afford industrially produced goods, albeit in the lowest price ranges.
In his book “The 86% Solution” Vijay Mahajan identifies this segment as the “biggest market opportunity of the 21st century” [76]. The 86% in the book’s title refers to the fact that the annual income of 86% of mankind is below $10,000. People in this income tier cannot afford products which are common in highly developed countries, such as automobiles or personal care products. But they will buy products which are much less expensive. With the ultra-low price range, a new and very large segment comes into existence. Every company must decide whether and most importantly how it can participate in this segment. This will only work with a radically different strategy if the company wants to still make money despite the ultra-low prices.
These developments are taking place not only in Asia but in Eastern Europe as well. Renault has been very successful with the Dacia Logan model, which it manufactures in Romania. The prices for the car start at €7990 and through 2017, Renault has sold more than 3 million cars [77]. The price for a typical Volkswagen Golf is more than double the price of the Dacia Logan. The prices for ultra-low price cars in emerging markets are even far below those of the Dacia Logan. The small Nano vehicle from the Indian manufacturer Tata has attracted a lot of attention around the world. The car costs just under $3000, but the Nano has faced major difficulties and has yet to achieve a big breakthrough in the market. Altogether, the ultra-low price segment comprises a very wide variety of small cars, and around 10 million of them have already been sold around the world. This segment is growing twice as fast as the overall automotive market.
Ultra-low price products are spreading rapidly in emerging countries. Consumer product giants such as Nestlé and Procter & Gamble sell very small pack sizes for a few cents apiece so that consumers with very low incomes can occasionally afford to use such products (e.g., a single-use pack of shampoo). In India, Gillette introduced a razor blade for $0.11, which is 75% below the price for established products. Ultra-low prices are also becoming more common in markets for industrial goods. This applies to medical devices and machine tools. Such products have already carved out substantial market shares.
An interesting question is whether the ultra-low price products from emerging markets can penetrate the high-income countries. There are already examples of this happening. The Dacia Logan, originally conceived for markets in Eastern Europe, has been a success in Western Europe as well. Siemens, Philips, and General Electric have developed simple medical devices meant for sale in Asian markets, but these ultra-low price devices are now being sold in the United States and Europe. They are not necessarily cannibalizing the market for much more expensive devices used in hospitals and specialized practices. To some extent, they are giving segments such as general medical practices access to these kinds of devices, which they can use to make some basic diagnoses on their own [78], expanding the overall market for medical devices.
2.6.5.2 Management
Product
Ultra-low price strategies have only one dominant aspect: extremely low costs. Everything else is subjugated to this criterion. It follows, then, that the product must be limited to only those functional attributes which are absolutely indispensable. Everything which is not a “must have” for the customer is left out. The entire process chain from development to procurement to production, sales, and service must be designed for the highest cost efficiency and simplicity. “The product concepts of machine tool and plant equipment manufacturers need to undergo a radical simplification if they want to conquer growth markets such as China and India,” one study says [79].
A company cannot develop ultra-low price products with engineers from high-income countries [80]. That means that one must not only establish production capability in emerging markets but research and development as well. Setting up the entire value chain within an emerging market is the only way to compete in the radically low-price ranges. The book “Reverse Innovation: Create Far From Home, Win Everywhere” analyzes this process and caused quite a stir [81]. For the Nano car in India, Bosch developed a radically simplified, extremely inexpensive common rail technology. The question of whether ultra-low price products can generate profits, and not only revenue, remains open.
An alternative to doing it alone is to acquire local companies which are active in the ultra-low price segment. The Swiss company Bühler, the global market leader in milling technology, took over Chinese manufacturers in order to keep up in the low-price ranges in China. According to CEO Calvin Grieder, this allows the company to achieve a better harmonization between product and customer expectations than would have been possible with their original higher-priced and more complex products from Switzerland. The world market leading manufacturer of industrial lasers, Trumpf, purchased a Chinese company as well. From 2014 to 2017, 32 Chinese companies have been acquired by German firms, typically with the goal to get access to the ultra-low price segment.
Karl Mayer, which has a 75% share of the global market for tricot machines, has been pursuing a two-pronged strategy. The goal is to secure a position not only in the premium segment but also in the lower-priced market segments. CEO Fritz Mayer tasked his development teams to develop products for the lower segment which have the same performance at 25% lower costs, and in the premium segment, to deliver 25% more performance at the same price. And the teams achieved these extremely ambitious goals. In doing so, Karl Mayer expanded its price and performance ranges both upward and downward, winning back market share in China.
Radical simplification makes a satisfactory level of functional performance at extremely low costs and prices possible. This definitely creates opportunities in developed countries. In this regard, the decision on an ultra-low price positioning is not only about the attractiveness of this segment in emerging markets but also about the potential backflow effect on industrialized countries with higher price ranges.
Price
The price is the overwhelming—one could argue the only—selling argument with an ultra-low price strategy. Roughly speaking, the prices for such products are 50–70% below the prices in the low-price range. As incomes rise, hundreds of millions of consumers in developing markets can afford industrially produced consumer and durable goods for the very first time. The following case from Vietnam is illustrative.
Honda is the world market leader in motorcycles. It is also the number one global manufacturer of small gas-powered engines, producing over 20 million units per year. Honda used to dominate the motorbike market in Vietnam, with a share of 90%. Its best-selling model, the Honda Dream, sold for the equivalent of $2100. As long as it faced no competition, it got along well with that price. Chinese competitors then entered the market with ultra-low price products. Their bikes sold for prices between $550 and $700 or between a quarter and a third of the price of the Honda Dream. These extremely aggressive prices turned market shares upside down. The Chinese manufacturers moved over 1 million bikes per year, while Honda’s volume dwindled from about 1 million to 170,000.
Most companies would have thrown in the towel at this point or withdrawn into the premium segment of the market, but not Honda. Its initial short-term response was to cut the price of the Dream to $1300 from $2100. But Honda knew it could not make money with this low price over the long term. And this price was still roughly twice the price of Chinese motorbikes. Honda developed a much simpler, extremely inexpensive new model which it called the Honda Wave. The new bike combined acceptable quality with the lowest possible manufacturing costs. “The Honda Wave has achieved low price, yet high quality and dependability, through using cost-reduced locally made parts as well as parts obtained through Honda’s global purchasing network,” the company said. The new product entered the market with an ultra-low price of $732, which is 65% less than the former price of the Honda Dream. Honda reconquered the Vietnamese motorcycle market so successfully that most of the Chinese manufacturers eventually withdrew.
The price range of 50–70% below previous price levels is typical for ultra-low price products.
In developing countries with low incomes, a company can only use ultra-low prices to defend itself against extremely price-aggressive newcomers.
Companies such as Honda, which come from the industrialized world and are normally positioned in the medium-price range, are able to compete against ultra-low price competitors in emerging markets. But they cannot succeed with their customary products. Instead, success demands radical reorientation and redesign, massive simplification, local production, and extreme cost consciousness.
Distribution
What we have said about production efficiency applies equally to distribution. Ultra-low prices only allow for tiny margins for third-party sellers/intermediaries, so they must be able to sell high volumes. There is no room for offering time-intensive consulting or generous levels of service or for indulging special customer requests. The Internet, with its high sales efficiency, is ideally suited for an ultra-low price strategy. One can expect that e-commerce will become an essential pillar of success in this segment. These products’ very limited complexity places few demands on sales and service personnel, which manifests itself in lower sales costs. In emerging markets, the service providers who offer repair and maintenance typically have only primitive tools. Auto repairs are often made on the side of the road. The ultra-low price products must take these conditions into account. Parts must be easy to remove and replace, in the simplest way possible.
Communication
The ultra-low price is the central communication message. There are no sizable advertising budgets available. The product needs to be so inexpensive that the media reports about it and thus provides free advertising. The Tata Nano is the classic example for this communication strategy. Because of its radical approach, the model achieved considerable attention in a short period of time. In Europe, the media reported on the Dacia Logan multiple times. Although ultra-low price products offer only the absolute bare minimum in functionality, they still need to deliver on quality. If this is the case, the chances for effective word-of-mouth advertising are good. Naturally, the Internet is a useful communications channel for these products, in particular the low-cost social networks. Models such as the Tata Nano or Dacia Logan receive an additional “pioneer” bonus, because they were the first products to crack the ultra-low price segment open. On its own, this does not build a reputation, but it does drive awareness. According to the AIDA model (attention—interest—desire—action), attention or awareness is the first step to market success.
Configuration of the marketing instruments of the ultra-low price positioning
Product | Price | Distribution | Communication |
|---|---|---|---|
• Only the most essential performance, forgoing anything which is not absolutely necessary • The simplest product design and use • Essentially no emotional, symbolic, or ethical performance • Few variants, in some cases only one | • Extremely low price, around 50–70% below market levels • No discounts or rebates, because there is no room to go down on price • Only one price; no price complexity | • Extremely low-cost distribution • The lowest possible level of consulting and service, to the extent it is offered at all • Online sales | • The price does the communicating • No paid communication efforts if possible • Free PR from “pioneer” status • Word-of-mouth advertising, also online over social networks |
As one sees, many elements of a traditional marketing strategy fall by the wayside when a company offers ultra-low price products. Extremely low costs and prices permeate the entire strategy.
2.6.5.3 Opportunities and Risks
The ultra-low price segments have the greatest growth potential. Professors Prahalad and Mahajan cited this years ago. With the growth in developing and emerging markets, hundreds of millions of consumers are going to have incomes which will allow them to afford industrially produced products for the very first time.
The reduction of the product to the absolute bare necessities is a prerequisite for success. Robust simplicity is what matters. At the same time, the products cannot be too primitive. It could be that the Tato Nano falls short on that last aspect, while the Dacia Logan has surpassed that hurdle.
The product development must take place in the emerging countries; that is the only way to develop suitable solutions for this segment. Building up an R&D department in these countries as well as an innovation process carries considerable risks.
Securing the lowest manufacturing costs with the appropriate design and producing the products in lowest-wage plants carry an equal portion of opportunities and risks.
This lowest-cost mentality extends to marketing and sales methods, as well as the service approach. The products must be easy to use and easy to maintain, in line with the low education level of the users and the limited range of tools available to service providers.
The extreme cost pressure can put quality at risk. To ensure sustained success, the quality of ultra-low price products must be both acceptable and consistent.
The core challenge of an ultra-low price strategy lies in establishing the value-to-customer in a way that will be accepted by a sufficient number of customers and allow for the associated radical minimization of costs.
2.6.6 The Dynamics of Price Positioning
The positioning of a product, a brand, or a company requires a clear and steady long-term orientation. Image and price position cannot be changed quickly or at will. But markets are dynamic. Technology, costs, consumer behavior, and competition are in constant flux. Regular review and examination, and, if needed, an adjustment of the performance profile and the price position, are therefore warranted.
Various developments, such as a shift in customer preferences, could precipitate changing a product’s price range, entering a previously unserved price segment or exiting certain price segments. Over the last 20 years, in some markets the medium-price segment has thinned out to the benefit of both the premium and the low-price segments. Coffee exemplifies this trend—while McDonald’s sells a small coffee for only $1, a Starbucks specialty coffee drink can cost more than $5. One retailer noted that “consumers almost always buy products on sale” presumably at the expense of the medium-price products. Another complains about the flood of discount prices and says that “the customers draw down their supplies until their brand is on sale again, which happens more or less every 4 weeks” [82]. On the other hand, consumers are preferring new methods of preparing coffee such as Nespresso at prices which are many times higher per cup. A recent study revealed supermarket pod or cup sales—including brands such as Nespresso, Tassimo, and Dolce Gusto—could overtake standard roast and ground coffee [83]. When such shifts occur, a company must put its established price position under review.
A typical trigger for repositioning is a new technology, which comes with increasing performance and/or lower costs. This can lead to corresponding consequences for the price positioning of established products. For example, traditional telecommunications companies have come under price pressure due to the Internet, cable companies, or entirely new models such as Skype, WhatsApp, or WeChat and had to significantly lower their prices as a result. In other cases, a price repositioning is not warranted. It would not make much sense for postal companies to cut the price of stamps in response to the introduction of e-mail, even though e-mail has largely taken the place of traditional “snail mail.” The marginal cost of an e-mail is practically zero, so any realistic price for postage would still be too high in comparison. Furthermore, these two forms of communication are not complete substitutes. For example, many invoices, checks, and similar documents are still sent by traditional mail.
Another trigger for price repositioning is a competitive entry. When the patent for a pharmaceutical expires, for example, one can expect the rapid market entry of knock-offs and generics. These new competitors enter the market at price points far below those of the original product. The incumbent must consider potential price adjustments early on. Should the incumbent continue to sell the original product at its prevailing high price level? Should it cut the price sharply, thus entering a new and lower price range? Or should it offer its own generic form?
The global shaving and personal hygiene giant Gillette offers a classic example of premium pricing. For years it followed a strategy of continually raising prices as it introduced innovations (e.g., better design, more blades). The price for the Gillette Fusion ProGlide razor in the United States was more than twice as high as the price of its predecessor, the Mach 3 model. But resistance to Gillette’s high prices has grown in recent years. Online competitors have sensed an attractive opportunity, and several start-ups have begun to attack Gillette from below. Traditional consumer goods giants have recognized the potential and have responded accordingly. Unilever improved its ability to compete against Gillette by purchasing Dollar Shave Club for $1 billion in 2016. As a result, Gillette’s market share declined from 70% to 54%. Gillette, in turn, lowered wholesale prices to retailers by up to 20%, depending on the product and package size. This marks a significant departure from its original strategy of continually implementing higher prices in the premium segment.
A price repositioning in response to new competition can be impractical if the value or cost differences are too large. This has allowed high-speed train connections to replace air travel on some routes (e.g., in China, France, Spain, and Germany). Airlines cannot compete with these new offerings in terms of travel time or price. Thus, it would serve no purpose for the airlines to cut their prices. They either discontinue the route or accept a smaller number of passengers who continue to fly (e.g., business travelers).
In markets such as fashion, consumer goods, retail, and services, we see similar dynamics of market and price positions. For a time, one French clothing maker struggled with its price positioning in the premium segment. Our analysis revealed that the brand actually belonged in the medium segment. A price reduction of 15% on average caused a 45% increase in sales volume. Profit rose sharply, though, even at the lower prices, because the margin was still satisfactory. The brand Hugo Boss went the other direction, systematically working itself up into the premium segment. The same applies to Lufthansa, which used to be a state-owned company and now holds a top position in the global air travel market. But there are also repositioning attempts which failed or backfired. Walmart, which is a very successful retailer in the United States and in other markets, entered the German market by acquiring stores and repositioning them significantly lower in terms of price, in order to become profitable. The attempt failed and Walmart withdrew. It has also retreated from the South Korean market.
The long-term character of a price position grows out of the fact that it becomes binding. Once chosen and implemented, a price position cannot be changed at will and especially not in the short term. This applies even more acutely to an upward repositioning. J.C. Penney is a prime example of the dangers of rapid upward repositioning. The main cause of the binding effect lies in the inertia of customer perceptions and preferences. A repositioning from higher to lower would seem to be easier. When a premium brand enters into a lower price segment, this can lead to short-term volume growth. But at the same time, the profit situation of the company can deteriorate because the company’s processes, costs, sales, infrastructure, and culture—designed for a higher price position—are rarely competitive in lower segments. Successful low-price companies such as ALDI, Ryanair, Dell, or IKEA pursue fundamentally different strategies than classic medium- or premium-priced suppliers. These internal “givens” are difficult to change, if they are changeable at all. In this sense, a price position has a strong binding effect from both an external and an internal perspective.
Due to market, customer, or competitive dynamics, it can be necessary or sensible to fundamentally change an existing price position.
The challenges and risks associated with such a repositioning move are often underestimated. This is true for the fundamental feasibility as well as the time requirements. Such changes should therefore be undertaken with extreme care. Even after rigorous analysis, a high level of uncertainty will remain as to whether the repositioning will succeed.
A downward price repositioning can take place comparatively quickly, because a higher price image has a positive radiance in the market. Shifting to a lower price positioning, however, will often erode that image—a brand’s position in a higher market segment may be endangered if prices are extended too far downward (“overstretching”). The downward positioning may generate volume and revenue growth, but the effect on profits is dubious. Entry into a lower price segment must be accompanied by associated cost reductions. All levels of the value chain need to be prepared for higher cost efficiency and cost consciousness. For that reason, a downward repositioning requires an internal cultural transformation.
The upward repositioning of an existing brand proves even more difficult and protracted. Many functions (R&D, quality, design, sales) must be upgraded to deliver higher value. Before undertaking an upward repositioning, any company must ask itself whether it has the corresponding competencies or can develop them. The higher price positioning is by no means merely a challenge for marketing, price management, and communication. It gets into the internal fabric of a company. One of the biggest barriers lies in having the necessary patience and endurance. Such repositionings can take decades, as the case of Audi shows.
Creating a new brand is a serious alternative to a price repositioning of an existing product or brand. Companies do this in the form of second brands, multiple brands, or “fighting brands.” Separating oneself from the established price position and its associated image is normally less problematic and faster through a new brand. On the other hand, this is often a significantly more expensive approach, both short and long term. To make a clear separation work and stick, one generally needs stand-alone products, plants, designs, and sales channels. These additional expenditures only pay off when the new brand achieves sufficient volumes and margins.
An additional option is the acquisition of brands or firms already positioned in the desired price range. This approach can be advantageous due to its speed and the ability to limit risk. Luxury goods groups such as LVMH or Richemont have used acquisitions to build up and expand their highly attractive portfolios of brands. BMW pursued this path with Mini and Rolls-Royce. In the mass market, Volkswagen has added the Seat and Skoda brands while also adding Audi and Porsche and in the luxury segment Bentley, Bugatti, and Lamborghini.
But even with this alternative, the acquiring firm must have the competencies to lead the acquired brands successfully and sustainably in the corresponding price segment. These competencies are not a given, even when the acquiring firm is in the same industry, as the example of General Motors showed when it bought Saab. The same holds true for Ford when it acquired brands such as Volvo and Land Rover with the hope to establish itself in the premium segment or for Walmart’s attempt to enter the German market via acquisitions. The leadership demands on a premium manufacturer, never mind a luxury one, are totally different from the challenges a low-price supplier commands. Cultural barriers can cause the integration to fail. All of these factors should be considered when contemplating a price repositioning or entry into a new price segment.
2.7 Conclusion
Clearly defined goals are a prerequisite for professional price management. In practice, there is often a conflict potential between profit goals and revenue, volume, or market share goals. Achieving both categories of goals at the same time is difficult, especially in mature markets. Setting priorities is therefore essential.
Managers have traditionally assumed that market share has a strong influence on profit. More recent research, however, has raised skepticism about such a causal link. The impact on profit depends on how the market share is acquired. If it comes via low prices without corresponding low costs, one must question whether a positive profit effect exists. In contrast, if high market share is achieved through innovation and quality at a reasonable cost, causation is liable to exist.
Price is an important determinant of shareholder value. A company can create sustained shareholder value through the right price strategy. In the same vein, mistaken price strategies can destroy shareholder value and can do so quickly and permanently.
A company needs to make a conscious decision regarding the price range(s) in which it will conduct its business. We distinguish among five price ranges: luxury, premium, medium, low, and ultra-low. These segments are not sharply demarcated, nor do all of them necessarily exist in all markets.
Price segments are not static—they undergo changes. Hybrid customers shop in different price segments depending on the product category or the occasion. In some sectors, we observe that the medium segment is shrinking. The ultra-low price segment is most common in developing or emerging countries.
Price positioning is not confined to a product’s price. Behind it is value, which in turn consists of functional, emotional, symbolic, and ethical components. Each of these components must be designed to meet specific customers’ needs and thus generate willingness to pay.
The positioning determines the entire direction of the company in terms of R&D, design, technology, production, and marketing competencies. All marketing instruments must be aimed at supporting the desired position.
Luxury price segments are small but very lucrative in terms of growth and profitability. Luxury products differ significantly from the rest of the market. They are often manufactured by hand or in small production runs and typically have a long brand history. Price itself becomes a decisive status and prestige attribute, so that some parts of the price-response function actually slope upward. Manufacturers limit production volumes of luxury goods in order to keep the supply tight and the price high. Exclusivity in distribution, communication, personalization, and comprehensive service is part of the luxury offering. Top performance, if not perfection, in all facets is an absolute must.
Premium products offer high functional performance and distinguish themselves from medium-price products in terms of emotional, symbolic, and ethical performance. The high relative price signals lasting value and continuity. Premium products should avoid special offers as well as discount-driven compromises as much as possible. One should also pay attention to price maintenance. Distribution is selective and directed more toward quality than reach. Advertising emphasizes the emotional, symbolic, and ethical aspects.
For a medium-price position, both functional performance and price are at or around the market average. Emotional aspects and brand have a moderate importance. Product and price differentiation come into play. Controlled special offers and promotions can make sense. Multichannel approaches are used in order to achieve wide distribution. The communication focuses on performance or on the price-value relationship, but not on price alone.
The low-price position is based on a favorable price combined with sufficient functional performance. Here the challenge for the supplier is to understand what features to leave out without jeopardizing customer acceptance. Sales costs should be minimized, and the company should forgo offering additional services. Communications center on the low price.
The ultra-low price positioning is entirely about extremely low costs and prices. Anything that is not absolutely essential to the product is left out. Radical simplification along the entire value chain is required. This low-cost maxim applies to distribution and communication as well. The Internet plays a key role. This segment is likely to become very large in emerging countries. How far the ultra-low price products penetrate the developed world remains to be seen.
Market, customer, or competitive dynamics can necessitate the repositioning of a product, i.e., to change the price range. A downward repositioning has a good chance of success due to the positive resonance. But it can put the original established position in upper segments at risk and impede profitability if costs are not reduced accordingly. An upward repositioning in contrast is difficult and time-consuming. Either change would require a redesign of many functions (R&D, production, quality, design, sales) in order to be competitive cost-wise in lower segments or performance-wise in higher segments. As an alternative to repositioning an established product or brand, a company could consider creating new brands or acquiring existing brands in the targeted price range.
The price strategy sets the framework for tactical price decisions. It encompasses the establishment of goals, price positions, and how the company deals with changes in market structure. Operational price management can only be successful when these fundamental decisions are in harmony.