Competitive Pricing

How Does Competitive Pricing Work?

The competitive pricing strategy refers to a company setting prices based on the rates offered by competitors in the market for competing products.

Competitive pricing—often used interchangeably with the term “competition-based pricing”—is a strategy in which a business sets its prices based on those of its competitors.

Therefore, the company sets its product prices to align with the market rate set by competitors considered most comparable to its own offerings (or at least be in close proximity).

In practice, the competitive pricing strategy is most common in a commoditized market characterized by products where price is the only differentiator.

On that note, competition-based pricing is usually a function of a product becoming commoditized, rather than a discretionary growth strategy (i.e. reaction to market conditions, not a choice).

The pricing strategy is particularly useful in markets with many comparable products and services, where price is a significant factor in consumer decision-making.

The determinant of product prices is the pricing rates offered by competitors in the market, which is an external factor.

Other external market factors that can influence pricing include changes in inflation, interest rates, fluctuating exchange rates, and a global recession.

How to Implement the Competition-Based Pricing Strategy

Establishing an effective pricing strategy is necessary for a business to achieve sustainable growth and profitability, particularly in a competitive market.

The process of implementing a competitive pricing structure consists of the following steps:

• Step 1 ➝ Compile a List of Competitors and the Prices of Competing Products
• Step 2 ➝ Estimate the Value Received from the Customer and Compare the Features of the Competing Products (i.e. Question the Variance in Prices)
• Step 3 ➝ Set Product Prices Based on the Insights Collected (e.g. Quality, Features, Benefits)
• Step 4 ➝ Continuously Monitor the Market for Headwinds and Tailwinds to Adjust Prices Accordingly (Supply and Demand)

Competitive Pricing: What are the Characteristics?

The most common characteristics of competition pricing are as follows.

What is the Competition-Based Pricing Strategy?

The price range retrieved at the onset serves as a constraint on the pricing of the company’s products (i.e. “price ceiling”).

Ultimately, the market rate—the prices at which comparable products or services are currently selling for—is the main determinant of where the company sets its own prices.

In theory, the market rate should reflect the supply-demand in the market for the specific product or service, but competition is an external factor that can influence the market rate.

The most important step is for a business to objectively analyze where its product offerings stand relative to the market.

• Higher Quality Product ➝ Higher Prices
• Lower Quality Product ➝ Lower Prices

The nuance to competition-based pricing, however, is that competition pricing applies mostly to industries that have become commoditized over time, as mentioned earlier.

The estimation of one’s product and its value will be unreliable given the inherent bias, which causes customer feedback, supply and demand (i.e. historical sales data), and an independent appraisal from a third party like a consultant is recommended.

The market and consumer preferences are constantly changing. Therefore, a company’s pricing strategy should be routinely reviewed and adjusted if deemed necessary to compete with the rest of the market.

In effect, frequent analysis of the competitive landscape regarding pricing strategies improves a company’s understanding of the market and patterns in customer spending behavior.

The more practical approach to setting product prices under competition-based pricing is a hybrid approach that blends competition-oriented pricing with value-priced pricing.

In particular, the necessity to be attentive to the value proposition cannot be entirely neglected, even if not prioritized in competition-oriented pricing.

• Underpricing (Discount) ➝ If a product is priced at the market rate without further analysis, the business is at risk of needlessly underpricing their offerings and missing out on revenue (i.e. foregone income), which compresses margins.
• Overpricing (Premium) ➝ If a product is priced at the top range of the market rate, the business risks overpricing its products, which will inevitably cause a reduction in consumer demand, especially if the features and benefits of the competing products completely outclass the company’s product.

How Does Branding Impact Competition-Based Pricing?

Branding significantly impacts pricing strategies by enhancing the perceived value of a product or service, which allows companies to set higher prices.

However, in the context of a commoditized market, the term value alludes more so to reliablility, as opposed to differentiated product features.

Because of the importance of branding, incumbents like Proctor and Gamble (P&G) tend to dominate commoditized markets.

Why? Consumers recognize the brand and tend to associate established companies with attributes such as consistent quality and reliability making them opt to purchase their specific product, even if the value received from a comparable product from a lesser-known brand is virtually identical.

• Brand Communication ➝ Effective branding communicates unique value propositions and differentiates the product from competitors. Such differentiation supports premium pricing strategies by creating a distinct image that justifies higher prices in the eyes of consumers.
• Customer Loyalty (Branding) ➝ Strong branding fosters customer loyalty, which in turn reduces price sensitivity. Customers who are loyal to a brand are less likely to switch to competitors even if they offer lower prices — which serves as a barrier to entry (i.e. non-monetary switching costs). Loyalty results from consistent positive experiences, trust, and emotional connections with the brand (e.g. Patagonia). Companies can leverage customer loyalty to maintain or increase prices without losing their customer base, as loyal customers prioritize the brand over cost considerations.
• Market Leadership ➝ Branding also plays a crucial role in market positioning and gaining a competitive advantage (or “economic moat”). A well-positioned brand can target niche markets or higher-end segments, thereby justifying higher prices. Brands positioned as cost leaders, on the other hand, emphasize affordability and value through their branding efforts. Strategic positioning enables companies to adopt various pricing models aligned with their brand identity, ensuring that pricing strategies resonate with the target audience.
• Price Flexibility (“Flex”) ➝ Brands known for high quality have greater flexibility in pricing decisions. Perceptions of high quality allow companies to implement premium pricing strategies with confidence. In contrast, brands perceived as lower quality may need to compete primarily on price, often adopting competitive or penetration pricing strategies. Effective branding ensures that the perceived quality aligns with the desired pricing strategy, enabling companies to achieve their financial and market share objectives.

Note: The variance in prices between “premium” pricing and discounted pricing is not too wide in most cases. For example, the difference could be $5.99 versus $4.99.

What are the Different Types of Competitive Pricing?

The three main types of competitive pricing strategies are premium pricing, price matching, and loss leader pricing.

• Premium Pricing ➝ The premium pricing strategy consists of setting product prices above the market rate. The effectiveness of the strategy is contingent on the company demonstrating to consumers in the market and convincing them that the premium is worth the trade-off in value. Customers are often willing to pay more for perceived higher quality or, at times, even the perception of higher value (or scarcity).
• Price Matching (Market Rate) ➝ The price-matching strategy is a more risk-averse approach that communicates that the product is the most affordable option in the market for its value. Therefore, the priority here is to reduce customer attrition (or churn). The price-match tactic is normally used by companies to stop customers from switching to competitors for a better price on a commoditized product like toilet paper or napkins.
• Loss Leader Pricing ➝ The loss leader pricing strategy comprises intentionally setting prices below the market rate. The initial loss is deliberate because the conversion creates an opportunity to build a long-term relationship with a customer. The revenue earned will stem mostly from the company’s other offerings, while the loss is a tactic to get their foot in the door and initiate a dialogue for future business. Marketing a product at the lowest cost can attract a customer base quickly, but the effectiveness of the strategy is reliant on the proper execution of initiatives to generate expansion revenue via cross-selling, upselling, product bundling, and more.

Competitive Pricing: What are the Risks?

The central risk inherent to competitive pricing is an incumbent or new entrant pivoting its growth strategy to undercutting the market rate.

While adjusting prices can seem like an easy lever to pull to increase market demand, the long-term consequences must be understood. In short, the initial foothold will be short-lived, and the entire market will suffer from the price war.

Undercutting is a suboptimal, flawed pricing strategy and certainly not a sustainable customer acquisition strategy, yet certain near-term oriented companies continue to engage in such practices.

The reduction of prices to compete is not a sustainable strategy, especially over the long-term.

However, sometimes the reason for the price cut is not to achieve near-term growth. In fact, the company’s decision to cut prices could have been made in anticipation of a reduction in its short-term profit margins.

The strategic decision to cut prices is to underperform intentionally in the near term because the company can withstand a couple of periods of lackluster performance (i.e. enough cash reserves, favorable unit economics).

In comparison, competitors in the market might not have the “cushion” to remain afloat while margins are compressed and the volume of customer purchases is low from the reduction in prices.

However, the company that initiates the price-cutting must understand that the strategy of forcing out weaker competitors can easily backfire, especially in crowded markets.

The expectation that competitors in the market will sit idly can be a costly mistake for all market participants. Once the price war starts, price cutting can soon transition into a freefall, where none of the participants benefit, including the company that initiated the price war (i.e. a “race to the bottom”).