Competitive Pricing | Strategy Definition + Examples

What is Competitive Pricing?

Competitive Pricing is a method by which companies set the prices of their goods and services relative to the market rate set by competitors.

Therefore, competitive pricing—or “competition-based pricing”—is a strategy predicated on the notion that a business must set its pricing based on the current prices of its competitors in the market in order to compete in the market.

Competitive Pricing

Table of Contents

What is Competitive Pricing?
How Does Competitive Pricing Work?
How to Implement the Competition-Based Pricing Strategy
Competitive Pricing: What are the Characteristics?
What is the Competition-Based Pricing Strategy?
How Does Branding Impact Competition-Based Pricing?
What are the Different Types of Competitive Pricing?
Competitive Pricing: What are the Risks?

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.

Characteristic	Description
Market-Oriented Strategy	The competitive landscape and external factors dictate the competitive pricing strategy. For instance, businesses monitor prices set by competitors to adjust their own prices accordingly. Unlike cost-plus or value-based pricing, competition-based pricing does not consider internal factors such as production costs or the perceived value of the product. The focus is solely on the prices set by competitors, which can sometimes lead to sub-optimal pricing decisions (and foregone income).
Simplicity of Implementation	Competitive pricing is recognized for its simplicity and ease of implementation. Conducting research can be completed relatively quickly. However, the implicit assumption is that the market competitors performed in-depth diligence on the market and understood market demand.
Flexible Pricing Structure	Prices can be adjusted frequently in response to strategic shifts by nearby competitors. However, the rationale for the price change is not fully understood (i.e. “blind trust”). For example, cutting prices in response to a lack of demand versus deciding to use the product as a “loss leader” for upselling opportunities are entirely different.
Risk of Price Wars	The most significant risk that pertains to competition-based pricing is the potential for price wars. If businesses continuously chop prices to undercut competitors, the outcome is reduced profit margins and unsustainable pricing, which can have harmful ramifications on the entirety of the market, including all participants.
Brand Devaluation	Setting prices too low to compete with others can lead to the devaluation of a brand. Consumers have a behavioral tendency to view products sold at lower prices as lower quality (i.e. “cheap for a reason”). Hence, a steep reduction in prices can negatively deteriorate the brand’s perception. On the other hand, luxury retailers—who possess pricing power—have the optionality to raise prices to improve profit margins from the aforementioned fallacy prevalent in consumer spending behavior.
Commoditization	By focusing on price, above all else, businesses can face challenges in differentiating themselves from competitors. Establishing a unique value proposition can be near impractical, considering that prices in the market are the only differentiating factor. Given price-oriented compeition, margin compression across the entire industry (or sector) is inevitable.

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.

What is a Commoditized Market?

If a product is deemed a commodity in business, the product is widely available and interchangeable, with minimal variation or differences in value. Hence, consumers in the market will purchase the option most convenient (e.g. available at nearby stores) and cheap.

Why? The utility of the product is relatively the same, if not identical, from the perspective of the customer (or user).

In effect, the companies that operate in the market have limited “room” to raise prices (i.e. no pricing power), which causes a reduction in profit margins.

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.

How Should Early-Stage Startups Set Prices?

For startups entering a new market, setting prices in the bottom range is recommended to “test the waters” — barring extraordinary circumstances.

The market demand post-product launch should provide the most insights that dictate the pricing going forward.

However, note that product prices can be easily raised without tarnishing a startup’s brand equity. The reverse—reducing prices on a product once available on the market—is a material risk to an unestablished startup’s reputation and branding.

Considering incumbents have long-standing relationships with their customer base, the strategy should be centered around offering value that exceeds the product of existing competitors (including the switching costs).

Of course, there are exceptions to the rule, but the point remains that prices should come second to value early on. Once the startup becomes more established and gains some market traction, the pricing strategy should be more closely analyzed.

Early-stage startups should aim to disrupt commodized market (or not even enter the market), as opposed to competing on pricing with established incumbents.

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”).