Why You Don't Want to Be the Low-Cost Leader
When you select a pricing strategy--that is, decide how you wish to price your products or services--what is your goal? The first answer that comes to mind may be to maximize profits, but that isn't a good enough answer.
Think about it this way: When your company develops new products or invests in a new marketing campaign, what's the goal? To maximize profits. But that doesn't tell you what types of products to develop or which customers to target or what message to deliver.
Both Ikea and Mercedes want to maximize profits--and they use very different pricing strategies to do so--but we don't think of Ikea and Mercedes in terms of their pricing strategies. We think of them in terms of their products and positioning. Ikea is a fun, designer, starter furniture store; Mercedes is a luxury automobile manufacturer.
Both companies set their pricing strategies to be consistent with their overall goals and the vision of who they are. Price follows their corporate strategy--not the other way around.
What is your overall strategy? It's the general description of how you compete in the market. It is your sustainable competitive advantage. Your strategy should be based on how your product or service differs from your competition, from product features or location to marketing or the breadth or focus of your offering. It can be many things, but it shouldn't be price.
Related: How Pricing Can Power a Turnaround
Why not? Because pricing is not a sustainable competitive advantage. Prices can change almost instantly. Your competitor can change prices just as quickly as you can. What if you find that optimal price, that psychologically perfect price that magically makes all customers want to buy from you? Your competitors will copy it--immediately. Any competitive advantage you may gain with pricing is not sustainable.
The one time that pricing can be a corporate strategy is when the company is positioned as the low-price leader. That's Walmart. If you adopt low price as your strategy, then your business must be continually focused on lowering and controlling costs--like Walmart. You are attracting the price buyers, customers who are not loyal, but are looking for the lowest price. Once a competitor figures out how to sell a similar product for less, they will charge lower prices and you will struggle. If another company figures out how to sell products for less than Walmart, Walmart will be in trouble. Knowing this, Walmart maintains a laser-sharp focus on keeping costs down. If you make low price your strategy, you have to be like Walmart, continuously lowering your costs so your competitors don't catch up.
You may be thinking about a different price-based strategy. "My product is as good as a Lexus, but less expensive. I'm going to make that my strategy." Don't do it. You may be able to have that product positioning for a short while, but it's not sustainable. The market will morph, and your position may or may not exist in a few years. You have competitors on both sides of you, above and below, either of which may be able to steal your position, because your position is just price.
Consider Walmart's discount retail competition. Kmart is having a difficult time competing with Walmart. Same-store sales continue to decline even as they come out of the 2010 recession. On the other hand, Target's same-store sales figures are growing rapidly. What's the difference? Although there are many factors, one is that Target has a unique positioning. It is described as "trendy," "cool" and "a hip discounter." Kmart may have the Martha Stewart brand, but the company as a whole doesn't own a position. There doesn't seem to be any real differentiation between Kmart and Walmart--other than price, which Walmart wins.
Target's success isn't based on price. They could not beat Walmart in a low price battle. Target's success is because they own the unique positioning of "hip discounter." There is only room for one company with lowest prices, and that company is Walmart, at least for now.
The strategy of low-cost leader is a rough-and-tumble position. Everything is done without frills. Once you get too comfortable, someone else hungrier than you will do it with less and steal your position. This is not a fun position to defend.
Even for companies that aren't low-cost leaders, you must still focus some of your energy and resources on costs. Target, Kmart and every company in a competitive situation still win and lose customers based on their prices. And to have competitive prices, they must maintain relatively low costs. Price is a factor in every customer's decision, and if one company's costs are much higher than another's, then they run the risk of losing on price.
Related: The Dark Side of Discounts