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No one is free from price comparisons

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No one is free from price comparisons

Even if innovation and advertising do increase added value, loyalty at all costs does not exist. Customers can be both sensitive to the brand but disloyal to it, estimating that the price of the brand goes beyond the price span that they are willing to pay for the product category, and beyond the brand premium that seems reasonable to them given the added satisfaction which is expected. Distributors also have the same attitude.

During years of economic growth, the biggest brands were tempted to regularly increase their prices to maximise the overall profit accruing from a strong price premium and a large batch of loyal clients. For financial directors concerned about showing ever increasing profits, what does a price increase of a few pence or cents per unit represent? For the market, however, it now has the utmost importance.

In April 1993, one of the most famous brands, Marlboro, noting a slump in sales, was the first to put into reverse this inclination by unilaterally lowering its prices in the United States. Wall Street reacted badly, thinking the bell was tolling for brands: on that day the stocks of all consumer goods companies dropped significantly. More than a year later, in August 1994, Marlboro’s market share reached unprecedented heights (29.1 per cent), seven points more than in March of 1993 just before the famous ‘Marlboro Friday’.

In France 10 years ago, Philip Morris decided to bring down the price of Chesterfields from 11.60F to 10F at at time when competitors were preparing to pass on to customers the 15 per cent tax increase imposed by the government. Within two months the sales of Chesterfields jumped by 300 per cent. The market share of the brand went from less than 1 per cent to 12.2 per cent in two years. It became, in a year, the favourite cigarette for young people (71 per cent of buyers were under 25).

One may recall that Procter & Gamble significantly reduced the price of its brands in the United States in accordance with its brand boosting programme, thanks to the allocation of part of the savings accruing from an impressive programme to increase industrial productivity, marketing and sales. These price reductions were part of the EDLP (Every Day Low Price) policy which put an end to the myriad of micro-promotions.

These price reductions show that the brand has to stay within the core of the market if it wants to continue. This was discovered by European car manufacturers after first the Japanese and now the Korean invasion: they forced all car OEM (original equipment manufacturers) suppliers to reduce their prices by 20 per cent. Portable computer manufacturers also know that they must both innovate and reduce their prices.

Indeed, the price premium that pays for the superior added value is a differential concept. It says nothing of the standard, the reference level of the brand with which it is to compare. But nowadays in many markets this standard is falling in absolute value. If hard-discounters spread through Europe as they have in Germany, they can impose in certain sectors their own levels of price and quality as the standard that the branded products have to reckon with when setting their price levels. If brands leave their price premiums unchanged, they will not be able to hold their ground.

The preceding argument is a fortiori valid if the price premium is higher than the perceived added value of the brand. The brand then gets into a niche at a high-end segment of the market and watches its volume drop. As is shown in figure below, the latent savings unexploited by industrialists could represent up to 30 per cent of costs. It is true that part of the benefits linked to the product are sometimes not valued by customers or that the upgrade in production costs is not worth it in the customers’ eyes.

There is more to be gained by suppressing these costs and finding a new price competitiveness again. Besides, trade-off analyses demonstrate that the logic of ‘bigger and better’ can be counterproductive if it entails an increase in price. Beyond a certain performance threshold, utility slumps. There are also acceptable price thresholds: the rule for home computers is to always give the client more as long as the retail price does not go beyond the US$2,000 barrier.

The analysis carried out by OC&C has, however, two limits. First, it neglects, as do most economic analyses, the perceived value of the reputation and image of the brand: a brand does not only bring a product benefit.

Sources of price difference between brands and hard-discount products

Second, it is not obvious that price leaders set the standard price that will be the reference for customers when they compare prices. It all depends on the level of involvement of the customer and of the perceived difference! For years, low-priced colas existed but attracted no consumers.

Only recently have the Sainsbury’s and Virgin colas been able to challenge Coca-Cola. Creating a large shelf space for price-leader detergents will not in itself create a significant sales volume: the quality reference is set by Skip and Ariel. Customers know they are not getting the same quality when, for want of buying power, they fall back onto secondary brands and a fortiori on unknown brands.

At the other end, the Viva milk created by Candia, far from being perceived as a premium product, has become the milk that all milks should be like, the standard for milk, both modern and advanced. There are indeed other price-leader milks, but they are considered ordinary and lacking in character.

Any price decrease, if it does occur, should not therefore be conducted in comparison with the cheapest product of the category but with the products in the same segment aiming at the same need. The so-called ‘trammelhook analysis’ (Degon, 1994) demonstrates empirically that the brands which are successful are most of the time those that have the lowest price within their own segment.

To return to the Chesterfield case in France, the brand was withdrawn as early as 1988 from the declining segment of up market Virginia cigarettes (Marlboro, Stuyvesant, Rothmans) to be positioned in the segment just under it, that of ‘popular Virginia cigarettes’ (Lucky Strike, Gauloises Blondes). By pricing its pack at s1.5, it became the cheapest alternative within this segment and quickly became the leader. Since then, the brand has had to increase its price due to budgetary constraints from the government, but has kept this price positioning.

As a conclusion, a decrease in price has never in itself solved the problem of making sure a brand lasts. It does not increase added value but reduces costs. Moreover, a decrease in price on the part of the leader has important consequences in the long term: it will jeopardize the profitability of the whole sector for 20 years to come.

The leader should instead aim either to retrieve the standard of quality that the customer knows he is leaving behind if he chooses a cheaper product, or to enlarge the market. But to do this the company must invest: lowering prices too much will make financing this effort impossible.