Do you, like many retailers, also see the development of competitor prices as an important reference point for the purposeful setting of your own prices? This strategy of price optimisation, however, presents a huge challenge. If competitors decide upon price increases or reductions, each retailer has to ask themselves whether they will be following this pricing.
Which areas show high potential for the adjustment of prices to current market events has already been covered for you in our article “Successful by dynamic pricing”.
In today’s article, we show you which influences the pricing of competitors has on the decisions of a retailer.
Are companies more sensitive to price cuts than to price increases of their competitors?
Peter Dickson and Joel Urbany from the Ohio State University and the University of South Carolina surveyed managers from the retail industry to answer this question.
As early as in the 1930s, researchers postulated that retailers follow price cuts, but do not follow price increases. From our perspective, this seems somewhat understandable in the light of the prospect theory developed by Nobel laureate Daniel Kahnemann and his colleage Amos Tversky. The prospect theory states that individuals perceive losses much stronger than gains. In other words, losing a dollar hurts more than winning a dollar makes one feel happy. Hence, once a competitor cuts a price, the retailer may see upcoming losses from not being competitive any more, and thus follows the price drop. When confronted with a price increase, the retailer may fear losing a competitive edge, and thus hardly follows the increase.
Pricing: Price reductions tend to be more popular than price increases
Dickson and Urbany surveyed 174 managers responsible for pricing decisions in the retail food industry throughout the United States, inviting them to an experimental study to set prices in a certain setup with eight products after a smaller competitor had readjusted its prices. For most products, they could confirm the effect that managers initiate price cuts rather than price increases. They also found that the effect was strongest for highly visible and price-sensitive items. They also realized that if other players had already reacted to the price change before, the chances where higher that the managers followed the rivals’ change (whether it was in increase or a decrease).
Monitoring of price changes is essential to successful price setting
The researchers conclude that especially price changes for highly visible and price-sensitive items may lead to price wars. As price changes for goods are becoming more frequent now, we believe that retailers should be aware of these changes in the marketplace for different types of goods. With respect to price increases, signaling may become a method to show that one is willing to increase prices, trying to motivate competitors to follow. This means that after a price down round, price increases might be offered on a step by step basis.
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