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What is price leadership?

Price leadership is a phenomenon that occurs when a particular seller sets a price which then serves as a benchmark for the other market players. Setting prices for new product entries may be a good illustration of price leadership, yet the latter occurs not only when the new or unique products are introduced. 

In some cases, predatory pricing might also be an example of price leadership. Here's how it works: to get awareness and increase the customer base within the shortest time possible, a new market player sets the prices almost equal or even lower than product cost. As a result, the other players are forced to reduce their prices too, at least for particular types of products. The point is that price leadership does not necessarily imply setting the best or the highest price but is rather about setting trends which requires the competitors to react. 

The phenomenon of price leadership takes place across various types of industries and markets. However, it is more common under specific circumstances. Here they are: 

  • A limited number of competitors

  • Products are the same or very similar

  • The demand elasticity is relatively low

 

The very idea of price leadership is more relevant for specific types of products due to their roles in the portfolio. We would give the examples and discuss how it works in the sections dedicated to a price leader and price follower models. 

Price leader: when does it work best? 

In many cases, price leaders are large retailers with a diverse portfolio, high turnover rate, and a substantial amount of revenue under management. This statement is especially relevant for industries and segments with one player explicitly dominating the market. 

Here is an example: Walmart is the only retail giant represented in a small town. A few local stores selling groceries are the only competitors of a Walmart's mid-sized supermarket. Subsequently, the retail giant becomes a price leader in the grocery segment as the company's prices are used by competitors as a benchmark and reference.

If there are few market players with comparable capacity and turnover, price leadership gets more complex. What it means practically is that, in such cases, a single market player can hardly be a price leader within every product group. In other words, each company is likely to be a price leader only within one or several product groups. For example, retailer A is a price trendsetter for bakery products while retailer B sets the price benchmark for premium sweets. 

Notably, the price leader model might be relevant to various types of products from new entries to Key-Value Items (KVI). That's why it is so important for the business to identify the role every SKU plays in a portfolio. 

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Price follower or sometimes it's better to look at the market 

Speaking of price leadership, many retail people tend to think that being a price follower is always a worse scenario and the business should do its best to become a price trendsetter as soon as possible. However, such a statement is a rather superficial approach to pricing policy. Here is the point: being a price follower in some cases is much more beneficial and strategically advantageous than being a price leader.   

Price follower could be a winning model especially in case the competition-based strategy is used by a retailer. At this point, it is necessary to note that competitive or market-driven pricing is not as simple as it might appear. Moreover, in case a retailer lacks relevant and high-quality competitive data or relies exclusively on other players' prices disregarding dozens of other pricing and non-pricing factors, the competition-based pricing could have a devastating effect.  

Efffective use of a price follower model requires retailers to clearly identify the role of every SKU in a portfolio. For example, once the Best Price Guarantee (BPG) products are identified, the business has to ensure the prices for these SKUs are really best on the market. To do it, following other players' prices is inevitable. Again, being a price leader does not necessarily mean offering the best price and vice versa. Moreover, in some cases, becoming a price follower is the only way to ensure that the best offering is crafted. 

price-follower
How major chocolate producers on Ukraine's market changed prices during the 2014 crisis

As the world is overcoming devastating economic consequences of the recent COVID-19 pandemic, the competition-based pricing approach becomes more and more popular across the retailers. As dozens of new market players move their sales online, the competition intensifies and customers become more sensitive towards the price. In this case, pricing experts recommend retailers to be the last to increase the price. And the visual above shows how this advice works in practice also highlighting the effectiveness of a price follower model.

Price leader vs. price follower: what about synergy?

Speaking of price leadership in retail, using a single model of either price leader or price follower is hardly a sustainable approach. Each retailer's portfolio contains SKUs with different roles. The latter, in turn, may change depending on the product lifecycle stage. For example, the new entry product may, eventually, become a cash generator or join the group of long-tail products.

Subsequently, the most balanced and financially healthy approach implies the combination of price leader and price follower model, i.e. one or another approach is applied depending on the product's role in the portfolio. Now, the question is which particular types of SKUs should be priced using a leader model and vice versa. 

Before we'd specify the types of products towards which one or another approach works better, it is necessary to make a little disclaimer. And here it is: there are no strict rules limiting the application of a price follower or price leader model to particular types of products. What it means is that you can price some products (like, long tail items) using both models. The choice depends on the business goals, resources and data available, pricing strategy, and brand positioning of a retailer. 

At the same time, each model is applied towards some types of products more often compared to the other. In particular, the price leader approach is commonly used in regard to new entries and an exclusive range of products. The price follower model is, in contrast, usually used towards BPG products, as well as cash and revenue generators. Once again, these are rather dominating patterns but not strict rules. Moreover, there is also a group of products towards which both approaches are applied with a similar frequency. Among others, the statement refers to the products under promo campaigns or long tail items.

Advanced software: a boost for price leadership

It's pretty obvious that defining a role each product plays in the portfolio plays a crucial role while choosing either price leader or price follower approach. And that's where many retailers face challenges, especially in the time of increasing time transparency and tough competition. Hopefully, the algorithms behind advanced pricing software solutions can help to identify the role of each product on the shelf at every stage of its lifecycle. 

At Competera, we use a blend of top-notch technologies and sophisticated math (e.g. Graph theory, time-series based algorithm, etc) to segment products into various buckets (BPGs, long tail, KVIs Cash generators, etc) so you as a retailer can choose either price leader or price follower approach. Besides the assortment bucketing, Competera also helps retailers to identify the level of impact every competitor has on one's sales. So, you know exactly which players are really worth being followed.

true-competitors
Competera's 'True competitors' feature

These are only a few rough examples showing how Competera can help the business to thrive. Leave your contacts and we'll show you more opportunities and answer all questions that might have appeared.

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