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IF View - Issue No. 09

THE PRICE CUTTING
PROBLEM FOR
MARKET LEADERS

Issue No 09

Marketing Channel Strategy Consultants
USA - EUROPE - AUSTRALIA - BRAZIL - HONG KONG
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Introduction

A common problem facing the leading suppliers in most industries is managing piece competition among channel members. As a supplier’s market share grows, channel members become more likely to compete against each other for the same customers. Because the channel members are selling the same product, they often compete against each other on price.

Problems with Intra-Channel Price Competition

Resellers of market-leading products often complain that they make lower margins on these products than on other products. This is generally true, and is also generally acceptable. Resellers’ profitability is determined by unit margins, unit volumes and running costs. Although resellers of market-leading products earn lower unit margins, they also ship higher unit volumes and incur lower running costs (particularly selling costs) than resellers of second-tier products. However, price competition among channel members can become destructive for suppliers when:

  1. Channel members stop providing adequate customer service because they cannot afford to do so. In this case, customer satisfaction suffers and future sales are put at risk.
  2. Channel member(s) promote the supplier’s product as a "loss leader" by selling the product at or near cost in order to leverage sales of more profitable, complementary products. For example, a computer products dealer might sell a personal computer at cost in the hope of also being able to sell the customer more profitable software and peripherals.
  3. A "loss-leader" situation is dangerous because it encourages other resellers to discount prices to remain competitive or to drop the brand because it is unprofitable.

  4. Channel members carry the supplier’s brand only as a tool to attract customers. Once customers are attracted, they are switched to more profitable brands.

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Resolving Intra-Channel Price Competition

Suppliers must balance four key elements to successfully manage price competition.

1. Purchase price differential among channel members.

Price competition is almost always driven by resellers with the lowest purchase prices, or sometimes by resellers with lower relative overheads, such as mass merchants. For these resellers, the competitive advantage of low purchase price can logically be transformed into the competitive advantage of being able to offer lower selling prices. Suppliers must be very careful when offering volume discounts. Most importantly, suppliers must correctly set the pricing differentials (if any) at which different resellers purchase. But when doing so, suppliers must take care that their conduct does not amount to an inducement to a reseller not to sell below a price specified by the supplier.

2. Distribution intensity.

The likelihood of price competition increases as the number of resellers servicing a particular area or market increases. Culling excess resellers is usually difficult. However, it is not always necessary if other elements of the channel plan are successfully implemented.

3. Selection of channel members.

Channel member selection (as Employee selection) is one of the most critical elements in achieving long-term success. Channel members are often selected because they are "available" or "important", with no thought given to the impact of the new member on existing channel members. Destructive price competition often occurs when one or more channel members has a history of low-margin selling (discounting) when most other channel members do not. Suppliers must ensure that the margins available to resellers will enable all resellers to provide the necessary level of customer service.

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4. Reseller remuneration structure.

The forms of reseller remuneration vary greatly. Rebate structures are often more effective in combating price discounting than straight buying-selling relationships. In rebate schemes, resellers receive a portion of their compensation at the end of a fixed period. For example, a building products distributor might receive an account credit at the end of each quarter which is equal to four percent of products purchased during the quarter. Because the timing of such compensation is not immediate and the amount it is not known, resellers are much less likely to pass on such benefits to their customers in the form of lower prices.

Likelihood of Price Competition

 

Low

High

Number of Channel Members

Few

Many

Profile of Channel Members

Consistent

Varies.  Includes "Discounters".

Channel Member Purchase Price Differential

None.  All members purchase at the same price.

Wide.  High-volume buyers receive much lower prices.

Channel Member Remuneration

Includes Rebate Scheme.

Straight Buyer-Seller Relationship.

 

Conclusion

Intra-channel price competition is a situation that most market-leading suppliers should face. If a supplier does not face this challenge, the supplier probably has not achieved optimum market coverage. Price competition can be managed within the ambit of laws relating to trade practices. It must be managed before it becomes destructive.

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