Please click the link below for the second and third part of this “must read” series for any small business hoping to survive a price war.
- Know your enemy – Scan your environment and know your market structure
- The art of pricing – Pricing objectives and strategies
- The art of war – all war is based on deception – how to fight a price war!
There have been a lot of articles written about pricing, price wars and war gaming, and there has also been a lot written on the strategies and tactics required to avoid and or deal with a price war.
However most of these articles are written in the context of large corporations who are often well funded and have the professional managers, who have the requisite tools and capabilities to deal with a price war. There has been few to none written for small businesses. Although the guiding principles are the same for all “for profit” companies, some of the prescribed solutions are not apt for small businesses.
Before we discuss on price wars, it is important for small businesses to reflect in a structured manner their industry structure, market trends and define and develop a purposeful pricing objective. Only then can small businesses determine their pricing strategy let alone deal with or avoid engaging in a price war.
Strategic context of pricing
I have often wondered as to how much purposeful thought that small business owners and SME marketers have given to their pricing strategy.
Pricing strategically is a core requirement that will determine the long term sustainability of a small business entity. Pricing is the purse string of any company. You mess with it and you are damned!
Most small businesses that I have interviewed do not consider aspects beyond cost plus pricing to price their goods and services. There are multiple pricing tools and frameworks that a small business owner or a SME marketer can deploy to sustain and win in the market place.
Before we get into the different pricing frameworks and strategies and tactics to deal with a price war, it is important to consider a small businesses’ position in the market place, relative to the overall market.
In discussing real world competition which most small businesses encounter daily, it is important to first focus and truly understand the market structure.
Market structure in essence is the number of companies in the market and the overall barrier to entry for others to enter in your space.
For example, no small business can realistically aspire to be a utility or telecom operator as the initial investments are untenable and beyond the reach of most SMEs. In addition meeting government and regulatory requirements requires investment in a battery of lawyers and regulatory experts.
Additionally, hiring professional managers competent in the relevant technology or commercial aspects of the industry are certainly insurmountable for a small business investor.
Of course, most small business owners and SME marketers are smart and will not venture into such an endeavor. I am only attempting to illustrate an extreme example of what an entry barrier truly means.
If the entry barrier is low, then the long term profits prospects for a company is low as well. So remember that when you develop your SME plan or your annual operating plans, keep in mind that there are many others who can enter and disrupt your profits in your market space.
Measuring industry structure
First, here are some basics that small busiess owner must be aware of.
Perfect competition with an infinite number of companies and a monopoly are polar opposites. Monopolistic completion and oligopoly lie between these two extremes. Monopolistic competition is a market structure in which there are many businesses selling differentiated products. Oligopoly is a market structure in which there are a few interdependent firms.
In most global industry structures where small businesses operate in, fall almost entirely between monopolistic competition and oligopoly—perfectly competitive and monopolistic industries are few and are nearly nonexistent.
Marketers in large companies often use one of two methods to measure the industry structure. They are the concentration ratioandThe Herfindahl index.
The concentration ratio is the percentage of industry output that a specific number of the largest companies have. The most commonly used concentration ratio is the four companies’ concentration ratio. The higher the ratio is, the closer the industry structure will be to an oligopolistic or monopolistic type of market structure.
The Herfindahl index is an alternative method used by marketers to classify the competitiveness of an industry. It is calculated by adding the squared value of the market shares of all firms in the industry.
I personally prefer this method. There are 2 advantages of the Herfindahl index. It takes into account all companies in an industry, as well as it gives extra weight to a single company that has an especially large market share.
Also, the Herfindahl Index is the method used by the US Justice Department for allowing or disallowing mergers to take place. If the index is less than 1,000, the industry is considered competitive, whereby allowing a merger is actively considered.
Relevance of industry structure for small businesses
By now you must be wondering why all this is important. Classifying the industry structure is important because structure affects a company’s behavior. The greater the number of sellers, the more the likelihood that the industry structure in which a small business operates in is competitive.
The number of businesses in an industry plays a role in determining whether small businesses explicitly take other companies’ actions into account. In reality though, when there are many sellers as in monopolistic competition, they do not take into account their competitors reactions.
If you are running a retail store or restaurant, this might not be very important for you. However in the UAE and the Middle East region in general, there are many traders and distributors for large manufacturers or technology companies ranging from cell phones, computers, servers to sophisticated telepresence and medical equipment.
In addition, there are many boutique management and technology consulting companies competing with well known global brands. I am sure those businesses that are competing in these market spaces could see the relevance of really understanding their industry structure.
A word on monopolistic competition
By now you must also be wondering as to why a hyper competitive industry structure is called monopolistic competition. It seems so counter intuitive. It is so, because the “many sellers” characteristic gives monopolistic competition its competitive aspect. The need and capability for business proposition differentiation gives monopolistic competition its monopolistic aspect.
The relevance to small business owners and SME marketers is that they should ensure that their proposition is truly differentiated. If there is differentiate on, these unique value propositions should be communicated in the market.
This is a fundamental rule for any small business. Most small businesses operate in an environment where the enry barrier isvery low and where there are many sellers in the market. If thisd is the case, then if there is no unique value proposition or if the unique value proposition is not communicated, the business is doomed to fail.