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									 Kamikaze Pricing
 By: Reed K. Holden and Thomas T. Nagle


  Reed K. Holden is President of the Strategic Pricing Group, Inc., where he has conducted
  numerous industry seminars in the U.S. and Asia on pricing and competitive strategy,
  business market research, and loyal buyer behavior. Thomas T. Nagle is Chairman of the
  Strategic Pricing Group which helps firms in such diverse industries as telecommunications,
  pharmaceuticals, computer software, semiconductors, wholesale nursery, consumer retailing,
  and financial services develop pricing strategies. For further information on both, log onto:
  http://www.strategicpricinggroup.com.



P
                                                         entire industries into tailspins from which they
      rice is the weapon of choice for many              never fully recover.
      companies in the competition for sales and
market share. The reasons are understandable. No         Pricing Options
other weapon in a marketer's arsenal can be              Marketers traditionally have employed three pricing
deployed as quickly, or with such certain effect, as     strategies: skim, penetration, and neutral. Skim
a price discount. The advantage is often short-lived     pricing is the process of pricing a product high
though and managers rarely balance the long-term         relative to competitors and the product's value.
consequences of deploying the price weapon               Neutral pricing is an attempt to eliminate price as a
against the likely short-term gains.                     decision factor for customers by pricing neither
                                                         high nor low relative to competitors. Penetration
Playing the price card often is a reaction to a          pricing is the decision to price low relative to the
competitor and assumes that it will provide              product's value and to the prices of similar
significant gain for the firm. Usually, that's not the   competitors. It is a decision to use price as the
case. Firms start price wars when they have little to    main competitive weapon in hopes of driving the
lose and much to gain: those who react to the            company to a position of market dominance.
initiators often have little to gain and much to lose.
The anticipated gains often disappear as multiple        All three strategies consider how the product is
competitors join the battle and negate the lift from     priced relative to its value for customers and that of
the initial reductions.                                  similar competitors. When Lexus entered the
                                                         luxury segment of the automobile industry, the
Managers in highly competitive markets often view        car's price was high relative to standard vehicles
price cuts as the only possible strategy. Sometimes      but low relative to Mercedes and BMW. The
they're right. The problem is that they are playing      penetration strategy was defined not by the price
with a very dangerous weapon in a war to improve         but by the price relative to the value of the vehicle
near-term profitability that ends in long-term           and to similar competitive products.
devastation. As the Chinese warrior. Sun Tzu, put
it, "Those who are not thoroughly aware of the           Any of these strategies can be associated with a
disadvantages in the use of arms cannot be               variety of cost structures and can result in either
thoroughly aware of the advantages."                     profits or losses. To understand when each strategy
                                                         is likely to be successful, managers should evaluate
If marketers are going to use low, prices as a           their current and potential cost structure, their
competitive weapon, they must be equally aware of        customers' relative price sensitivities, and their
the risks as well as the benefits. They also must        current and potential competitors. All three areas
learn to adjust their strategies to deploy               must be carefully considered before employing any
alternatives when pricing alone is no longer             pricing strategy.
effective. Failure to do so has put companies and


                                                                 The Journal Of Professional Pricing              7
Penetration Strategies Can Work                          totally new brand as a flanking product, as
If a firm has a fixed cost structure and each sale       Heublein did with the Popov, Relska, and Smirnoff
provides a large contribution to those fixed costs,      vodka brands and Intel did with microprocessors in
penetration pricing can boost sales and provide          1988. After the introduction of the 386
large increases to profits-but only if the market size   microprocessor, Intel adopted a skim price strategy
grows or if competitors choose not to respond. Low       for the high value and proprietary 386 chips. It also
prices can draw additional buyers to enter the           wanted to market a circuit in the 286 market that
market. The increased sales can justify production       could compete with AMD and Cirrus on a nonprice,
expansion or the adoption of new technologies,           value-added basis. The 386 SX was introduced as a
both of which can reduce costs. And, if firms have       scaled down version of the 386, but at a price only
excess capacity, even low-priced business can            slightly higher than the 286. The net result was to
provide incremental dollars toward fixed costs.          migrate price sensitive customers more quickly to
                                                         the proprietary 386 market with the 386SX, while
Penetration pricing can also be effective if a large     still capturing increased profit from the high value
experience curve will cause costs per unit to drop       users with the 386.
significantly. The experience curve proposes that as
a firm' s production experience increases, per-unit      In its marketing of the 486 Pentium, and Pentium
costs will to down. On average, for each doubling of     Pro circuits, Intel continues this flanking strategy
production, a firm can expect per-unit costs to          with dozens of varieties of each microprocessor to
decline by roughly, 20%. Cost declines can be            meet the needs of various market segments.
significant in the early stages of production.
                                                     For penetration pricing to work there must be
The manufacturer who fails to take advantage of competitors who are willing to let the penetration
these effects will find itself at a competitive cost pricer get away with the strategy. If a penetration
disadvantage relative to others who are further price is quickly matched by a competitor, the
along the curve. This is often the                                    incremental sales that would
case with new technologies and                                        accrue from the price-sensitive
innovative products, where             “Many managers find            segment must now be split
relatively small increments in           that in winning too          between two competitors. As more
units sold yield substantial                                          competitors follow, smaller
                                       many pricing battles,
decreases in unit costs. This is                                      incremental sales advantages and
                                      they often lose the war lower profits accrue to both the
also the case for many, new
entrants to a market who are just          for profitability”         initiator and the followers.
beginning to see experience curve
cost reductions.                                                      Fortunately, there are two
                                                         common situations,       which often cause
However, the main ingredient to successful           competitors to let penetration pricers co-exist in
penetration pricing is a large segment of customers markets. When the penetration-pricing firm has
for whom price is the primary purchase motivation. enough of a cost or resource advantage,
This can be the case in business markets where competitors might conclude they would lose a price
original equipment commodities are sold to the war. Retailers are beginning to recognize that some
production process of a customer's business, but it consumers who are unconcerned about price when
rarely occurs in       consumer markets where deciding which products and brands to buy become
image is an important part of the use of a product.  price sensitive when deciding where to buy. They
                                                     are willing to travel farther to buy the same
When Omega watches - once a brand more branded products at lower prices. Category killers
prestigious than Rolex - was trying to improve like Toys 'R' Us use penetration pricing strategies
market share in the 1970s, it adopted a because the are able to manage their overhead and
penetration pricing strategy that succeeded in distribution costs much more tightly than
destroying the watch's brand image by flooding the traditional department stores. Established stores
market with lower priced products. Omega never don't have the cost structure to compete on this
gained sufficient share on the lower price/lower basis, so they opt to serve the high-value segment
image competitors to justify destroying its brand of the market.
image and high-priced position with upscale
buyers. Similar outcomes were experienced by the The second situation conducive to penetration
Cadillac Cimarron and Lacoste clothing.              pricing occurs when large competitors have high
                                                     price positions and don't feel a significant number
A better strategy would have been to introduce a of their existing customers would be lost to the

                                                                The Journal Of Professional Pricing              8
penetration pricer. This was the case when People's        though customers may want to buy a low-priced
Express entered the airline industry with low              product, they don't increase their volume of
priced fares to Europe in the 1970s. The fares were        purchases. Price cuts used to get them to switch
justified with reduced services such as no                 fail to bring large increases in demand and end up
reservations or meal service. People's also limited        shrinking the dollar size of the market.
the ability of the high value business traveler to
take advantage of those fares by not permitting            A prominent example is the semiconductor
advanced reservations or ticket sales. This was a          business, where earlier price competition led to
key element of their strategy: Focus only on price         both higher demand and reduced costs. But in
sensitive travelers and avoid selling tickets to the       recent years, total demand tends to be less
customers of their competitors.                            responsive to lower prices, and most suppliers are
                                                           well down the experience curve. The net result is
Major airlines didn't respond to the lower prices          an industry where participation requires huge
because they didn't see People's Express taking            investments, added value is immense, but because
away their high value customers. It was only when          of a penetration price mentality, suppliers can't
People's began pursuing the business traveler that         pull out of the kamikaze death spiral.
the major airlines responded and quickly put
People's out of business.                                  There was a time when large, well-entrenched
                                                           competitors took a long time to respond to new,
The same strategy is being repeated today by               low-price competitors. That is no longer true:
Southwest Airlines in the domestic market far more         domestic automobiles are now the low priced
skillfully. Southwest has a cost structure that            brands, and even AT&T has learned to respond to
limits the ability of major airlines to respond. In        the aggressive price competition of Sprint and MCI.
fact, when United Airlines, a much larger                  The electronics, soft goods, rubber, and steel
competitor, did try to respond with low-cost service       companies that ignored low-price competitors in
in selected West Coast markets, it had to abandon          the 1970s and '80s have become ruthless cost and
the effort because it couldn't match Southwest's           price cutters. The days of free rides from non-
cost structure.                                            responsive market leaders are gone.

Penetration or Kamikaze?                                   Another risk comes in using penetration pricing to
An extreme form of penetration pricing is                  increase sales in order to drive down unit costs.
"kamikaze" pricing a reference to the Japanese dive        Unfortunately, there are generally two reasons
bomber pilots of World War II who were willing to          managers run into trouble when they justify price
sacrifice their lives by crashing their explosives-        discounts by anticipated reductions in costs. First,
laden airplanes onto enemy ships. This may have            they view the relationship between costs and
been a reasonable wartime tactic (though not a             volume as linear, when it actually is exponential -
particularly attractive one) by commanders who             the cost reduction per unit becomes smaller with
sacrificed single warriors while inflicting many,          larger increases in volume. Initial savings are
casualties on opponents. But in the business               substantial, but as sales grow, the incremental
world, the relentless pursuit of more sales through        savings per unit of production all but disappear.
lower prices usually, results in lower profitability. It   Costs continue to decline on a per unit basis, but
is often an unnecessary and fruitless exercise that        the incremental cost reduction seen from each
damages the entire dive-bombing company-not just           additional unit of sale becomes insignificant.
one individual-along with the competitor. Judicious        Managers need to recognize that experience curve
use of the tactic is advised: in as many cases as it       cost savings as a percentage of incremental sales
works, there are many more where it does not.              volume declines with increases in volume. It works
                                                           great in early growth phases but not in the later
Kamikaze pricing occurs when the justification for         stages.
penetration pricing is flawed, as when marketers
incorrectly assume lower prices will increase sales.       Many managers believe that sales volume is king.
This may be true in growth markets where lower             They evaluate the success of both their sales
prices can expand the total market, but in mature          managers and marketing managers by their ability
markets a low price merely causes the same                 to grow sales volume. The problem is that their
customers to switch suppliers. In the global               competitors employ the exact same strategy.
economy, market after market is being discovered,          Customers learn that they can switch loyalties with
developed, and penetrated. High growth, price              little risk and start buying lower priced
sensitive markets are quickly maturing and even            alternatives. Marketers find themselves stuck with


                                                                  The Journal Of Professional Pricing             9
a deadly mix of negligible cost benefits, inelastic       higher prices when they get caught up in kamikaze
demand,       aggressive    competition,  and   no        pricing. To avoid this, they need to understand how
sustainable competitive advantage. Any attempt to         their customers value different product and
reduce price in this environment will often trigger       company attributes. The objective is to identify
growing losses. To make matters worse, customers          segments of customers who have problems for
who buy based on price are often more expensive to        which unique and cost-effective solutions can be
serve and yield lower total profits than do loyal         developed. Sometimes it's as simple as a minor
customers. Thus starts the death spiral of the            adjustment in packaging.
kamikaze pricers who find their costs going up and
their profits disappearing.                               Know what customers want. Loctite Corp., a
                                                          global supplier of industrial adhesives, introduced
Penetration pricing is overused in large part,            a specialty, liquid adhesive in a 1 -oz. bottle for use
because managers think in terms of sports instead         in emergency applications. Unfortunately, sales
of military analogies. In sports, the act of playing is   were less than spectacular. After a number of
enough to justify the effort. The objective might be      customer interviews, Loctite discovered that the
to win a particular game, but the implications of         liquid was difficult to apply, and the bottle was
losing are minimal. The more intense the process,         difficult to carry. What customers really wanted
the better the game, and the best way to play is to       was an easy-to-apply gel in a tube. The product
play as hard as you can.                                  was reformulated to meet these criteria and saw
                                                          huge success. In the process, Loctite almost
This is exactly the wrong motivation for pricing          doubled the price.
where the ultimate objective is profit. The more
intense the competition, the worse it is for all who      Managers should identify features that they can
play. Aggressive price competition means that few         add more cost effectively than their competitors
survive the process and even fewer make                   can. IBM has been under intense price pressure in
reasonable returns on their investments. In pricing       the    personal    computer     segment.    Besides
the long-term implications of each battle must be         introducing lower-priced flanking products (with
considered in order to make thoughtful decisions          limited success), IBM also has introduced
about which battles to fight. Unfortunately, many         computers with more internal memory. This feature
managers find that, in winning- too many pricing          had significant appeal because of the higher
battles, they often lose the war for profitability.       memory demands of the Windows 95 operating
                                                          system. The value of this feature was greater than
Value Pricing                                             a price cut because IBM is arguable, the most cost-
To avoid increasingly aggressive price competition,       effective producer of random access memory in the
managers must first recognize the problem and             world. It also forced low-price competitors to incur
then develop alternate strategies that build              higher relative costs to match IBM, thereby
distinctive, nonprice competencies. Instead of            undercutting their ability to price their PCs below
competing only on price, managers can develop             IBM's.
solutions to enhance the competitive and profit
positions of their firms.                                 In the process of adding value to their products,
                                                          firms should remember that value is achieved not
In most industries, there are far more opportunities      only from the products themselves but from the
for differentiation than managers usually consider.       services   associated    with   their   use.   The
If customers are receiving good service and               manufacturer of a heavy-duty truck oil broke out of
support, they are often willing to pay more to the        commodity pricing when it began analyzing the oil
supplier, even for commodities. A client in India         from its customer's trucks to determine if there
produced commodity gold jewelry that was sold             were excessively high temperatures or metal in the
into the Asian market at extremely low penetration        oil that would indicate a breakdown of the internal
prices. Because of the client's good relationships        components of engines. The service was promoted
with wholesale and retail intermediaries, we              in a mailer included with each large drum of oil.
recommended a leveraging of those relationships to        The cost of this service was minimal, and a large
increase prices to a more reasonable level. Despite       segment of small- and owner-operator customers
much anxiety, the client followed suit and major          placed a huge value on it. This tactic helped the
customers accepted the increases.                         firm to differentiate its product with a valued
                                                          service connected to the product.
Opportunities to Add Value                                Offer complete benefits. Another way to avoid
Marketers often fail to recognize the opportunity for
                                                          downward pricing is to offer complete product

                                                                The Journal Of Professional Pricing            10
                                                                                                  lowest possible price for products. These
      F ig u re 1
      C u s to m e r p u rc h a s in g a g e n d a
                                                                                                  commodity buyers have multiple vendors and
                                                                                                  encourage them to dive into kamikaze price wars.

                             high
                                                                                                  For consumer marketers, price shoppers who
       Pain of Expenditure
                                           P ric e -S e n s itiv e       V a lu e -S e e k in g
                                               Segm ent                      S egm ent
                                                                                                  switch allegiances at the drop of a coupon provide
                                                                                                  few incremental dollars to the retailers who cater to
                                    C o n v e n ie n c e -S e e k in g         Loyal
                                                                             S egm ent
                                                                                                  them. For business-to-business sellers, these tend
                                              S egm ent
                                                                                                  to be the buyers who scream loudest and dictate
                             low




                                                                                                  pricing and selling strategies. Unfortunately, the
                                    lo w
                                            V a lu e o f D iffe re n tia tio n
                                                                                     h ig h
                                                                                                  profits they generate rarely justify the attention
                                                                                                  they demand.

benefits, which is especially useful in the early                                                 The price buyer's agenda is to get products at the
phases of a new product's life. This tactic is not as                                             lowest possible prices, so he or she uses tactics
effective when products mature and customers no                                                   that force marketers to employ kamikaze pricing
longer need as much service support. However,                                                     tactics even when it might not be the wisest thing
when customers are still developing their expertise,                                              to do. For the marketer, the trick is only to do
they require complete systems to achieve the                                                      business with the price buyer when it is profitable
maximum benefit to their organization. This is                                                    to do so and when it doesn't prompt a more
often an expensive affair that needs to be justified                                              profitable customer to purchase elsewhere.
by the future business and profit potential that a
customer represents.                                                                              Convenience buyers don't care whose product they
                                                                                                  purchase, and have little regard for price. They
Understand customer agendas. Marketers make a                                                     simply want it readily available. This often is the
serious mistake when they assume that all their                                                   most    profitable    market    segment,     provided
customers are willing to sacrifice quality to obtain                                              marketers can deliver their products at the
low prices. A few are, but most really want to get                                                locations preferred by these buyers. Unfortunately,
high-quality products at the lowest possible price.                                               this group exhibits little brand loyalty and provides
The seller of a high-quality product can compete                                                  sellers with no sustainable competitive advantage
against a low-price, low-quality, product by                                                      beyond their distribution systems.
recognizing that despite the words of the
purchasing agent, pricing need not be too                                                         Offer the best deal. Value buyers evaluate vendors
aggressive.                                                                                       on the basis of their ability to reduce costs through
                                                                                                  lower prices or more efficient operations, or to
Sellers who understand why customers buy their                                                    make the buyer's business more effective with
products often find that there is a fairly uniform set                                            superior features or services. From a customer
of reasons underlying purchasing behavior. Price is                                               perspective, this is the place to be: while both price
often important, but it seldom is the sole                                                        and loyal buying have unique costs, value buying
motivation. In most business situations, there are                                                comes with the assumption that these customers
four types of agendas with regard to the pricing of                                               are getting the best deal possible, given all factors
products and a buyer's desired relationship with                                                  of consumption. From a marketing perspective,
the supplying firm. One of the best ways for                                                      firms that attract value customers get the loyal
marketers to avoid the trap of excessive price                                                    buyer as part of the bargain and sell to the price
competition is to develop market- and customer-                                                   buyer only when it is profitable and reasonable.
level strategies that reflect those behaviors.
                                                                                                  Organizations that employ kamikaze pricing have a
For example, loyal customers highly value specific                                                poor understanding of how their products create
things that a supplier does for them, such as                                                     value for customers. This lack of understanding
technical support, quality products, and customer-                                                results in excessive reliance on price to obtain
oriented service agents. These customers are less                                                 orders. Successful marketers use price as a tool to
concerned about the price than about the care they                                                reflect the value of the product and implement
receive. They often have a single supplier and have                                               systems in the organization to assure that value is
no intention of qualifying another. Understanding                                                 delivered to customers and captured in the pricing.
who the loyal customers are and keeping their
loyalty, is critical.                                                                             Reprinted with permission from Marketing Management,
                                                                                                  published by the American Marketing Association, Reed
Conversely, price buyers care little about a long-                                                Holden & Thomas T. Nagle, Summer 1998/Volume 7.
term relationship with a supplier and want the

                                                                                                        The Journal Of Professional Pricing           11

								
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