Pricing and the Competitive Landscape

Usually when we use the phrase “the competitive landscape,” we’re looking to enter a market and trying to decide how it looks. Is this a market where we want to play or not?

Pricing offers a unique perspective on this question.

First, remember that costs are essentially irrelevant to pricing. What really matters is how much customers are willing to pay. However, when deciding whether or not to enter a business, costs become extremely important. Both fixed costs and variable costs play a role. Today we’ll focus only on the variable cost aspect.

A key component in looking at the competitive landscape is your competitors’ margin. If they’re selling an extremely high-margin product, there may be room for competition. This is a strong indicator that competition isn’t driving the price down toward costs. Of course when you enter, your competitors may choose to compete on price to hold their market share – but at least it doesn’t start that way.

If your competitors are selling at relatively low margins – and especially if they’re low relative to what you’re willing to accept – then you have to decide if you’re adding enough extra value to charge higher prices. Alternatively, do you have a strong cost advantage, meaning you can manufacture at a much lower cost than your competitors? Something has to be different if you want to enter the market.

Before you enter the market, ask yourself: “What price will I be able to charge?” Use value-based pricing to see how much your product will be worth relative to your competition. If you plan to price lower than your competitors, have a justifiable belief on how they’ll respond. Will they ignore you because you’re the new kid in the market? Will they aggressively compete to not lose any share? You need to predict your prices and your competitors’ responses. If they compete aggressively, will you have enough margin in your product to meet your company’s goals?

Although costs rarely matter when setting prices, they are critical in deciding whether or not you want to be in a business. Determine your pricing upfront – including your competitors’ reactions – then decide if you want to enter the market.

Costs matter when deciding to enter a business. Knowing your pricing upfront is necessary to predict profitability. Understanding pricing will help you understand your competitive landscape.

Originally posted on Mark’s Pragmatic Marketing blog Pragmatic Pricing.