Surya ran an Indian coffee brand that his grandfather started. The organization manufactured filter coffee, enjoying the majority market share in southern India and moderate sales in other parts. Since filter coffee involves an elaborate making process and most people consume instant coffee, Surya came up with the idea of blending the two. He decided to launch a brand of instant filter coffee, something that wasn’t seen before. He’d already decided his approach and wanted to become a price leader to have an immediate impact. He studied the price leadership model and price leadership example before setting his objectives and devising strategies. This decision sent ripples through the industry as it meant every single brand had to rethink their strategies and change their pricing. Organizations took a cue from his model as they considered him a successful price leadership example among Indian coffee brands.
Want to know more about price leadership? Read on.
What Is Price Leadership?
Price leadership is a strategy by which an organization creates a situation to influence the price of services or products in the market. It is quite common in a homogeneous market where there is little to no difference between services and products offered by organizations operating in that market. The price leadership model is commonly seen in an oligopolistic market, such as airlines, where competition is low. One of the advantages of price leadership is that it compels the competition to rethink strategies to compete with the price set by the dominant organization, also known as a price leader.
A price leader is usually a large organization that operates with low production costs. This puts them in control of undercutting prices charged by competitors. As there are lesser organizations operating on inelastic demands, a price leader often adopts such a strategy to restrict new emerging competition. Some conditions influencing the emergence of price leading are:
- Organizations that accurately identify industry trends are likely to make profits despite the competition. They can implement the price leadership model as a preventive method to deal with the expected market changes. This compels competitors to either match prices or invest in resources that can identify such trends.
- As organizations with large capacity have the ability to operate in multiple locations and cater to a substantial customer base, they get the liberty to undercut prices. Smaller organizations that don’t match these prices lose their market share.
- Owning patented technology lets an organization charge reasonable prices for services and products. It becomes easier for them to deploy a price leadership model since they deliver high-quality and advanced features, which build consumer trust.
- Since customers prefer both quality and productivity, they’re more likely to select the organization with superior execution methods. It’s more common in services offered on hourly or contract bases and lets organizations adopt price leading as a method of dominating the market.
Organizations quite often implement price leading methods when consumer demand is high for a specific product. It’s a proven tactic of luring customers away from competing brands. In such a case the price of this product becomes the market leader!
Types Of Price Leadership
Based on these market factors, price leadership is divided into three models. They are:
In a barometric model, an organization takes the lead position in the industry by identifying changing market conditions and adapting to these shifting market forces. They establish themselves as the first to spot and respond to these changes. Even a small organization can be a barometric price leader and other big organizations will follow them to match prices instead of waiting to witness those changes.
The collusive model is common in oligopolistic markets. There are few industry players who collude to set prices of services or products. It happens in industries where production cost is known and cost of entry is high. Such agreements must be made keeping in mind the operating costs of the firm. If the prices are not related to operating costs and the aim is to defraud people, then such agreements are deemed unlawful.
A dominant model is one that involves a dominant organization that controls the majority of the market share. It is surrounded by smaller businesses that try to compete with their products and prices, allowing the big one to enjoy a partial monopoly. The dominant firm has the liberty to set a lower rate according to supply and demand and smaller firms have to follow to save their market share. However, if prices are lowered to unsustainable levels to kill the competition then it might be considered illegal.
Price leading methods are usually adopted by big organizations that have the capacity to lower rates and retain profits since they produce multiple products at low costs. Smaller firms may have the ambition to depend on technology, research and development to capitalize on trends and predict market shifts or they can choose to enter into an agreement with other firms to protect their market share.
Advantages Of Price Leadership
Although price leading allows one organization to drive prices across an industry, it holds several potential advantages for other firms in the market as well. These are some advantages of price leadership:
If a price leader sets prices for specific products and competitors match that price, all players enjoy high profits as long as customer demands remain steady. This means that competitors can increase their prices to replicate the leader’s price and still gain profits and retain market share.
Minimize Price Wars
Among the advantages of price leadership, reducing price wars is a significant one. A market having organizations of the same size is bound to witness price clashes as competitors look to increase their respective market shares. An organization can choose to enter into an implicit or explicit agreement with its competitors to solidify its market share or match the leader’s price to avoid losing it.
Once an organization establishes itself as a price leader, it can use the additional profits to add features to its products, improve designs or reinvent the product altogether. An organization can provide a good product at a cheap rate or charge premium rates for premium products, but they have to use their resources to research and develop improved products in order to create demand.
The price leadership model can be profitable for all businesses in an industry, but it does have its drawbacks. It’s a reason for unfair competition, as big organizations can lower prices by using operating synergies to levels that become unsustainable for smaller businesses. Even if a small firm matches the price to retain its share, it can lose profits in the long run and exit the market eventually. Similarly, when a price leader increases their product prices other organizations follow suit. This causes customer dissatisfaction and businesses can incur significant losses.
Price Leadership Example
Now that we know what price leadership is, let’s look at a few examples:
Reliance JIO is a popular price leadership example from recent years. They launched the network by offering free calls and internet to its users. In an age where people rationed their data usage, JIO offered unlimited data daily. People didn’t have to worry about call rates and durations as JIO offered unlimited free calls and text messages across any network in the country. This move compelled other telecom giants to rethink their pricing and modify it accordingly. Once JIO gained a significant customer base, they changed the pricing of its packages, which were not free anymore but reasonably priced. The newer pricing forced other networks to change their pricing again to match JIO’s rates to retain their remaining market shares.
At a time when people had to pay hefty amounts to avail of good airline services, Indigo emerged as a low-cost provider with standard services, becoming a price leadership example for other businesses. Indian airlines offered premium services, but their rates were high. Other smaller airline operators charged much less but offered poor air services. Indigo used the barometric model to identify the rise in demand for airway services and a balance between fares and facilities. They offered good services at rates higher than the smaller operators but much lower than the premium ones. This forced other services to adjust their prices and service qualities to suit people’s demands and retain market shares.
Price leadership is often used by strong organizations to show their presence and dominance in a market. In most cases, smaller organizations find it beneficial to follow a price leader and avoid incurring losses due to price wars. Ambitious organizations can choose to rely on advanced techniques to set the trend and identify inevitable industry changes. Managers must learn financial analysis and avoid mistakes that make price leadership a means to monopolize the market and charge high rates from customers instead of using it purely as a business strategy.
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