Retail is cutthroat, and the rise of inflation has led to an increase in price sensitivity among consumers (Brandwatch, 2023). Businesses are feeling the squeeze of a volatile economy as they struggle to balance rising operational costs with competitive pricing strategies to boost profit margins.
Throughout the years, the ‘follow the leader’ model has been the default approach despite its well-documented limitations. The strategy involves setting the prices based on the decisions of key competitors. It’s a copycat tactic that can expose you to a myriad of vulnerabilities, including potentially reduced profit margins.
While competitor pricing can be effective and is used by some of our clients, it can also lead to a “blind leading the blind” scenario.
While competitor pricing can be effective and is used by some of our clients, it can also lead to a “blind leading the blind” scenario
Below, we’re going to explore the dangers of the follow the leader pricing strategy and how it can undermine the profitability and competitive edge of retailers.We will also discuss the need for more sophisticated pricing strategies and provide best practices for moving away from this flawed approach.
Risks and pitfalls of 'Follow the Leader' pricing
Lack of differentiation
When retailers adopt identical pricing through a follow the leader strategy, it often sparks price wars. In a bid to remain competitive, companies continuously lower prices to match or undercut each other, leading to a race to the bottom. It’s a vicious and relentless cycle that erodes profit margins as businesses sacrifice profitability and neglect price optimization for short-term sales boosts.
The consequences can be severe. Smaller profit margins demand compromises, leading to a chain reaction of damaging effects: less investment, lower quality, reduced innovation, and decreased customer satisfaction.
When this happens, it can tailspin any business into financial instability.
Difficulty in maintaining brand identity and value perception
Pricing is an opportunity for any business to distinguish itself from the competition. Adopt the same price points as your competitors’ prices and you’ll fade into the mosaics of the market. This lack of differentiation can lead to customers perceiving products as interchangeable, undermining the distinctive attributes that set a brand apart.
What’s more, consumers associate price with value (Branding Strategy Insider, 2024). Implementing a premium pricing strategy will elevate the perceived value of your product. A low cost pricing strategy will make consumers more likely to question the quality of your product.
Therefore, if you regard yourself as a premium brand, adopting a competitor’s lower pricing strategy can confuse customers, and erode your perceived value.
Vulnerability to competitor mistakes
Mistakes are inevitable in business. Your competitor might be flying blind with their pricing model, and mirroring theirs will inevitably put you on a rocky course.
A notable example is J.C. Penney’s “Fair and Square” pricing strategy, which decided to adopt the market’s everyday low pricing model. In 2012, CEO Ron Johnson introduced this approach, eliminating discounts in favor of straightforward pricing, assuming consumers would appreciate the simplicity.
However, it failed to resonate with price-sensitive customers, leading to a 25% drop in sales and a net loss of $985 million in one year (Paddle), (Harvard Business School) (Harvard Business School).
Reduced pricing power
The economy, brand identity, and financial health are unique factors that determine a business’s pricing model. Adopting a competitor’s pricing strategy mismatches these factors with the company’s unique market positioning.
As a result, the business may lose pricing power, leading to reduced profitability and weakened brand identity. This misalignment can decrease customer loyalty, as prices may no longer reflect perceived value, weakening competitive pricing effectiveness.
Moreover, failing to manage pricing aligned with internal costs and strategic objectives can compromise responsiveness to market conditions and competitive threats.
This brings in a crucial concept called pricing elasticity – a process that measures how sensitive the quantity demanded of a product is to a change in its price. Understanding pricing elasticity helps businesses determine how much they can adjust their prices before significantly impacting sales volumes.
Keeping you on the back foot with a reactive approach
A follow the leader pricing strategy is reactive, as it adjusts prices based on competitors’ actions rather than the company’s own cost structures, value propositions, or strategic objectives.
This leads to inconsistencies, erodes customer trust, and reduces profitability. Copying competitor prices can cause destructive price wars and diminished margins. This approach often misaligns with the company’s cost structures and value propositions, leading to long-term strategic issues.
In contrast, a proactive pricing strategy sets prices based on thorough market research, cost analysis, and the value delivered to customers. This method enhances profitability and customer loyalty by ensuring prices reflect true value. Companies with proactive pricing strategies often experience better financial performance and market positioning (McKinsey & Company).
Ignoring customer value
Another disadvantage of competitor pricing is that it may not reflect the true value of your product or service in different customer segments. This happens when prices are set based on competitors’ actions rather than on the perceived value by various customer groups.
It’s flawed because the market decides the value of your product. As a result, understanding your customers’ willingness to pay and preferences is crucial for setting optimal prices.
Through 7Learnings’ platform, you can achieve this by analyzing detailed product-level data (PLV) to understand what different customer segments value and are willing to pay. Products that drive repeat purchases are highlighted, giving you the information to accurately align prices with perceived value.
The need for sophisticated pricing
Advanced pricing strategies provide a more nuanced approach than simple competitor price matching. Here’s a summary of what each strategy entails and how they can impact profitability:
- Value-based pricing: Ensures prices reflect the true value perceived by customers, often leading to higher willingness to pay.
- Dynamic pricing: Optimizes revenue by adjusting prices in response to market changes, a tactic successfully used by companies like Amazon.
- Predictive pricing: Leverages data analytics to anticipate demand and adjust prices accordingly, improving both sales volumes and margins.
It will come as no surprise how impactful data can be when determining your pricing strategy. In fact, studies from McKinsey highlight that companies using advanced analytics for pricing achieved a 2-7% increase in return on sales within one year (McKinsey & Company).
How to adopt a sophisticated pricing model
Data is at the heart of any modern pricing approach. Without it, your pricing strategy will lack accuracy and will fail to reflect customer preferences and market dynamics.
Using tools like 7Learnings, companies can analyze product-level data, identify high-value items, and apply predictive analytics. This allows businesses to create dynamic pricing strategies based on comprehensive insights.
With these insights, users can anticipate market changes and adjust prices proactively.
They’ll also have the foresight to anticipate market changes as well as the agility to adjust prices proactively through effective demand forecasting.
And what does this lead to?
Higher profit margins with greater consistency and less effort.
Follow the leader pricing is costly and outdated
We live in the digital era where every business decision, action, or move can be scrutinized in granular detail. Data is the backbone of every decision and it should be when creating your pricing strategy.
Relying on outdated and reactive models like ‘follow the leader’ pricing leaves your business vulnerable to market missteps and eroded profit margins. A modern pricing model will give you the insights required to tailor your pricing to the preferences of your target market, allowing you to thrive and survive in today’s fiercely competitive digital arena.
If you want to find out how 7Learnings can help you modernize your pricing strategy to optimize your profit margins, then make sure to book a free demo now.
