Competitors can reduce their price for a variety of reasons, including reacting to the launch of your product, selling off inventory in the run-up to the release of a new product, or in a strategic shift to win more market share. Below are a couple of approaches to navigating competitor price reductions.
Percentage breakeven sales
A good first step when considering a competitive price reduction is to calculate the percentage breakeven sales change and make a judgment call on whether to change your price or not.
First, a definition. “Contribution Margin” is the incremental money generated for each product sold after deducting the variable portion of the product’s cost. For example, if the current price of your product is $50, and the variable cost is $40, then the contribution margin is $50 less $40, or $10. The percentage breakeven sales is calculated by dividing the potential price reduction by the product contribution margin.
For example, if a competitor reduces their price by 5%, the percentage breakeven sales change for the same 5% reduction in your product is the price reduction (5% of $50 or $2.50) divided by the contribution margin ($10), or 25%. As a first-order analysis, if you believe that by not matching the competitor price, sales volume will be reduced by 25% or less, then it is better not to match the competitor price change since doing so would result in lower overall profit.
On the other hand, if you believe sales will drop by more than 25%, then a price reduction should be considered. In deciding, you also need to consider whether the competitor price reduction was a one-time or temporary event. Perhaps the competitor is preparing for the launch of a new version of the product and is temporarily reducing the price to sell off their remaining inventory with the intention of reverting to the prior price for the next version when launched. If so, a price reduction on your part may be unwise and unnecessary. On the other hand, if you believe that a price reduction on your part may result in the competitor further reducing price, then you need to account for that when determining the appropriate course of action.
Cost of responding and competitor strength
Another approach is to estimate (1) the total cost of reacting to the competitive price reduction as well as (2) the strength of the competitor, and respond in one of four ways:
- Ignore – Ignoring the competitive move is prudent when the competitor is weak, and the cost of reacting outweighs the benefits. Matching the price reduction may also only precipitate a further, more painful reduction.
- Accommodate – When the competitor is strong and responding would be too costly, it is best to accommodate the competitive move and make the strategic changes necessary to address this new reality.
- Defend – When a response is cost-justified, and when dealing with a strong competitor, then the best strategy is to engage and defend your market position. The goal here is to convince the competitor to “play nice” and to signal that aggressive pricing is not in the competitor’s best interest. This may involve a temporary price reduction on your part with a subsequent price increase to signal your intent.
- Attack – Sometimes, a weak competitor misjudges their market strength and initiates a price reduction in the hope of gaining market share, only to be outdone by a strong response on your part.
Read more about pricing and other key product management topics in my book, Mastering Product Management: A Step-By-Step Guide, available now in paperback and eBook.