The Pricing Advisor by ert634


									   The Pricing Advisor
                    3277 Roswell Rd., Suite 620 Atlanta, Georgia 30305 USA

             A       Professional Pricing Society Monthly Publication

                    Object Of The Game: Avoiding Price Wars
                                                                             Both players, acting
   According to David Dunne The University of Western Ontario game           independently and in full
   theory can analyze strategic interaction and it can analyze the           knowledge of each other's payoffs,
   impact of changes in pricing strategy - and help avoid destructive        choose strategies that lead to the
   competition. Dr. Dunne proposes following these principles to help        worst possible outcome for both -
   avoid destructive price wars: 1. Choose your game. 2. Understand          each prisoner goes to jail, because
   each player's role. 3. Understand what strategies are available to        they deem it always in their
   your competitors. 4. Understand what information is available. 5.         interest to betray each other.
   Learn your competitors' payoffs. 6. Understand what drives your
   competitors' behavior. 7. Provide incentives for cooperation and          Prisoners Dilemma sheds light
   penalties for defection. E.M.                                             on why price wars happen.
                                                                             Instead of prisoners, imagine that
                                                                             the two players are firms Coke
                                                                             and Pepsi or Lever and Procter &
Game Scenarios That Apply             convict either prisoner, the police    Gamble, for example. Given a
                                      hold them in separate cells and        choice between maintaining price
To Pricing
                                      press each to give evidence            and cutting price to gain share,
Price wars are a "lose-lose"
                                      against the other. They tell both      the Prisoners Dilemma predicts
situation. They are destructive
                                      prisoners the same story: if           firms will cut price, and,
and unprofitable, but avoidable.
                                      neither betrays his or her             moreover, will do so repeatedly.
Here are 2 classic game scenarios
that lay the foundation to price      colleague, both will be sentenced
                                      to one year in jail. If both           In 1994, the pricing strategy of
                                      prisoners betray each other, then      Rupert Murdoch's New York
                                      both will go to jail, but in view of   Post showed an understanding
To Co-Operate Or Not To Co-           their co-operation, the judge will     of these principles. The Post
Operate                               be lenient and give them only          raised its price from 40 cents to
The police officer and the prisoner   eight years in jail. If one prisoner   50 cents, but its chief competitor,
in the above scenario are players     betrays the other, but is not          the Daily News, did not follow.
in the famous Prisoners Dilemma.      implicated, that prisoner will be      Instead of lowering the Post's
Its story follows.                    released immediately, and the          price to 40 cents again, Murdoch
                                      police will ask the judge to give      announced his intention to reduce
The police arrest two individuals     the other prisoner the maximum         price to 25 cents. When the Daily
strongly suspected of robbing a       sentence - 10 years in jail.           News did not respond, Murdoch
local bank. Lacking evidence to                                              reduced the Post's price to 25

                                      INSIDE THIS ISSUE
 Tough Sell: Commodity Products ………………………….                                          4

 Sticker Shocks In Euro Land ………………………………..                                          7
                                                                                               March 1999
The Pricing Advisor Newsletter
A        Professional Pricing Society Monthly Publication
3277 Roswell Road • Suite 620 • Atlanta, GA 30305 770/509-9933 • Fax 770/509-1963 Internet:

cents in a Staten Island test
The Daily News got the message         The one who swerves is branded
and raised its price to 50 cents,      "chicken," and the one who stays         competition, taking into account
followed shortly thereafter by the     in the center of the road is the         what they know about us, what
Post.                                  hero.                                    we know about what they know,
                                                                                and so on. The following
Murdoch's strategy was nice            Obviously, if both stay in the           principles can help you avoid
since he started out by raising        center, the result is disaster.          destructive price wars.
price, provocable since he             Yet, if both drivers swerve, both
reduced price when the Daily           live but are branded cowards.            1. Choose Your Game. The
News did not follow, forgiving         The driver who stays while the           competitive game you play is a
since he raised price to 50 cents      other swerves, is covered in             matter of choice, not the cards
once the Daily News had done           glory.                                   you are dealt. Chicken, for
so, and clear since the intent                                                  example, is a risky game many
was obvious to the Daily News.         Drivers' Decision                        businesses prefer not to play
Both competitors won, since            If you and your competition              However, once involved in a
they were more profitable at the       seem to be playing Chicken,              game of Chicken, your only
higher price.                          your strategy should be as               recourse is to play according to
                                       follows:                                 its rules.
The benefits of Murdoch's
strategy and may seem obvious          Threaten: Show, through your             In the battery market, Duracell
with hindsight. Yet, Murdoch           actions, that you will retaliate if      and Energizer have been famous
succeeded because he                   your competitors defect. Act             for their intensely competitive
understood the key principle of        quickly and decisively in                advertising- Duracell's wind-up
game theory: understand your           response to any price reduction.         toys versus Energizers
competitors and make your                                                       ubiquitous bunny. Intense as
competitors understand you.            Punish: Demonstrate that price           the competition is, it is not
                                       reductions will have disastrous -        based on price. Both
So, if your strategy is clear to       even suicidal - consequences. Do         manufacturers have chosen to
your competitors, and                  not simply match the price, but          use advertising as their
demonstrates that you are              punish the price reduction by            competitive arena.
ready to co-operate but will           cutting yours as far as possible.
punish betrayal, you can win                                                    To change the nature of the
over time. However, your               The idea is to show that cutting         game, you need to think about
competitors also gains by              price is highly likely to bring a        your competitors' payoffs. To
cooperating, so this is truly a        decisive, mutually destructive,          avoid price wars, develop
"win-win" strategy.                    response from you. Chicken               strategies that reward non-
                                       illustrates the value of signaling       price responses from your
Threatening For Everyone's             your intentions to competitors. If       competitors.
Benefit                                they think that you are crazy
                                       enough to stay in the center of          2. Understand Each Player's
If you've seen the classic James                                                Role. In Prisoners Dilemma and
                                       the road - wage a price war -
Dean movie, Rebel Without a                                                     Chicken, the players were equal:
                                       they'll think twice before
Cause, you'll appreciate the                                                    the same strategies were
                                       initiating any aggression.
game of Chicken.                                                                available, and they received the
                                       Avoiding Price Wars                      same payoffs. Two unequal
In the game of Chicken, two                                                     players could develop a form of
drivers start at opposite ends of      Game theory's strength is that it        understanding - so long as each
a straight road. They race             forces us to look at competition         accepted its role.
toward each other.                     in a new way - from both our
                                       own point of view and that of the

                                                       2                                                March 1999
The Pricing Advisor Newsletter
A        Professional Pricing Society Monthly Publication
3277 Roswell Road • Suite 620 • Atlanta, GA 30305 770/509-9933 • Fax 770/509-1963 Internet:

Competitors also need to take
into account relevant non-             understand what information is
players' influence on the game.        available to them. You should            cutting prices in the hope that
While Coke and Pepsi thought           not assume they will read                you will not respond. To
they owned the soft drink              your intentions perfectly.               understand your competitors'
market, the growth of formerly                                                  motivations, your research
                                       By understanding where the               needs to get inside their heads.
insignificant private labels put       gaps are in your competitors'
intense pressure on them to            information, you can help                You need to consider corporate
reduce prices.                         provide the missing information.         culture and the temperament of
                                       The Daily News' strategy in              the individuals who influence
3. Understand What Strategies          reducing price in a restricted           decisions. You should also
Are Available to Your                  area cleared up any uncertainty          examine your competitors'
Competitors. Your competitors          the Post might have about its            response to past strategic
may not have the flexibility you       aggressiveness.                          changes.
do. For example, an independent
gas station may be able to             5. Learn Your Competitors'               7. Provide Incentives for Co-
change prices more quickly than        Payoffs. To predict your                 operation and Penalties for
a multinational outlet, so the         competitors' reactions to your           Defection. It is critical to make
latter may not be able to respond      pricing moves, you need to               your intentions clear to your
quickly and appropriately              understand what they stand to            competitors. By acting swiftly
to a price increase. Similarly,        gain or lose from each strategy.         and decisively in response to
firms in difficult financial straits   While it may be difficult to get         price cuts, you can show that
think primarily of short-term          precise data on your                     price wars will be costly to your
survival, and are more likely to       competitors' payoffs, it should          competitors. When
initiate a price war. Thorough         usually be possible to develop an        Chesebrough-Pond's launched
research on your competitors           understanding of their rank              Trust deodorant into a test
can reveal the constraints they        order of preferences, based on           market in British Columbia,
are facing and their likely            estimates of demand and costs,           major competitors responded by
response to your moves.                and on managerial judgment.              offering high-- value coupons. In
                                                                                doing so, they signalled that
4. Understand What                     6. Understand What Drives                entering the deodorant
Information is Available.              Your Competitors' Behavior.              market would be a tough
History is replete with tragic         While your competitors' behavior         struggle for Chesebrough--
decisions made on the basis of                                                  Ponds - the brand was never
incorrect or insufficient              may appear irrational, it is more        launched nationally.
information. Price wars often          likely that they have a different
start because one competitor           perception of reality from you.          At the same time, you also need
misunderstands the other's                                                      to show your competitors a way
intentions. To judge your              Some competitors may have a              of responding that is not
competitors' most likely reaction      high tolerance for risk, and may         mutually destructive. For
to your moves, you need to             be willing to "roll the dice" by         example, a timely price
                                                                                increase on a high-profile item
                                                                                can be all that is needed to
                                                                                end a price war.

                                                       3                                                March 1999

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