The Pros and Cons of Competitive Pricing: A Complete Guide

Competitive pricing is one of the most common pricing strategies used by businesses today. With this strategy, companies set prices based on their competitors’ prices rather than basing prices solely on costs or desired profit margins.

Competitive pricing can be highly effective in certain situations. However, like any pricing model, it also has some potential downsides In this comprehensive guide, we’ll explore the pros and cons of competitive pricing to help you determine if it’s the right strategy for your business

What is Competitive Pricing?

Competitive pricing involves setting prices relative to your competitors’ prices for similar products and services The goal is to ensure your prices are in line with the rest of the market,

There are three main approaches to competitive pricing:

• Pricing below competitors: Setting lower prices than rivals to attract customers away from competitors. This can work well if you can maintain profit margins through higher volume.

• Pricing the same as competitors: Matching competitors’ prices so customers have no incentive to switch based on price alone. This helps maintain market share.

• Pricing above competitors: Setting higher prices than competitors while justifying the premium through product quality, branding, or other advantages. This works best for established brands with price inelasticity.

Competitive pricing is most common in markets with many rivals, transparent pricing, and undifferentiated offerings where small differences in price can sway purchase decisions.

The Pros of Competitive Pricing

Competitive pricing offers several potential benefits:

1. It’s easy to implement

One of the biggest advantages of competitive pricing is its simplicity. All you need to do is research your competitors’ pricing and set yours accordingly. There’s minimal complexity involved.

This makes it a very accessible strategy for small businesses without sophisticated pricing processes and data analytics capabilities. The basic research required also makes it a cost-effective approach.

2. It carries lower risk

Basing prices on established market rates significantly reduces risk compared to setting prices based on uncertain projections and assumptions. You know you’re aligning with customer expectations since your prices mirror competitors.

This low-risk approach helps avoid scenarios where you overprice and lose business or underprice and leave money on the table. Matching the market typically provides a “safe” middle ground.

3. It can deliver quick results

Since competitive pricing pegs your prices to market standards, it allows you to gauge and adapt to price trends rapidly. You can quickly see what impact your pricing changes have on market share.

This level of pricing agility empowers you to course correct as needed to achieve business goals. You don’t have to conduct lengthy pricing studies.

4. It can supplement other pricing models

Competitive pricing doesn’t necessarily have to be your only pricing approach. It can effectively complement more cost-based or value-based strategies.

For example, you could first set prices based on costs and desired margin then compare with competitors to ensure alignment. This provides a competitive perspective to enhance other pricing methods.

The Cons of Competitive Pricing

However, competitive pricing also has some downsides to consider:

1. It can lead to missed optimization opportunities

Strictly pegging prices to competitors can result in missed optimization opportunities. You may end up sticking with suboptimal prices rather than proactively adjusting based on profit maximization data and models.

This reactive approach focuses more on maintaining current market share versus actively improving profitability through pricing. Significant money can be left on the table.

2. Competitors may make pricing mistakes

Basing prices solely on competitors leaves you vulnerable if those competitors use flawed pricing strategies and set incorrect prices. You may inadvertently adopt the same inefficient or unprofitable prices.

This risk highlights the need to view competitive pricing as just one input for your strategy rather than the sole determining factor for pricing decisions.

3. It can promote price erosion

Matching competitors’ prices, especially engaging in price undercutting, trains customers to expect lower and lower prices over time. This can kickstart a race to the bottom that erodes profits across an entire industry.

Unless you have detailed data proving a lower price maximizes revenue, competitive price cuts can easily spiral out of control.

4. It doesn’t consider willingness to pay

Customers ultimately decide prices through their willingness to pay. Competitive pricing overlooks this by focusing strictly on rival prices. Just because competitors use certain prices doesn’t necessarily mean those prices optimize revenue.

The ideal price is the highest amount a customer is willing to pay. Competitive pricing doesn’t account for this strategic concept of value-based pricing.

5. It can lead to price wars

Aggressive competitive pricing tactics like undercutting can ignite price wars that damage profitability across an industry. This typically happens when one company initiates a price cut and competitors retaliate with further cuts to recapture market share.

Price wars tend to produce a few short-term winners but many long-term losers. A race to the pricing bottom is difficult to reverse.

6. It may not support differentiation

Pricing identical to competitors makes it impossible to use pricing as a point of differentiation and competitive advantage. You miss the opportunity to employ strategic pricing to influence customer perceptions of your brand.

This commoditization effect is especially detrimental for brands aiming to establish a premium market positioning. It hinders the ability to stand out versus rivals.

7. Customers may doubt quality

In some cases, ultra-low competitive pricing can backfire by giving customers the impression your products are inferior or cheaply made. Customers often associate low prices with low quality.

Unless you are pursuing a low-cost provider strategy with efficient operations to support bargain prices, severe undercutting can negatively impact brand equity.

Best Practices for Competitive Pricing

While competitive pricing has drawbacks, you can maximize its upside and minimize its downsides by following these best practices:

• Conduct detailed competitor research – Rigorously research rivals’ pricing across all products/services, channels, geographies, customer segments, promotions, and other relevant dimensions.

• Use competitive pricing as an input, not the only factor – View competitive pricing data as one key input to inform – not dictate – pricing decisions.

• Avoid reactive price wars – Refrain from reactive price-cutting in response to competitors’ moves. Only lower prices proactively based on data.

• Monitor competitor pricing regularly – Check competitors’ pricing frequently to detect changes and quickly adapt pricing as needed.

• Leverage pricing software – Use pricing software to automate competitor price tracking and analysis for faster, data-driven pricing.

• Test different price points – Experiment with prices above and below competitors to gauge customer demand signals at different price levels.

• Communicate value, not just price – When pricing above competitors, clearly convey the additional value customers receive to justify higher prices.

Competitive pricing can be an effective strategy when used judiciously, but it requires careful execution. Blindly matching competitors’ prices without also considering costs, customer demand, and value perceptions can lead to suboptimal pricing.

The key is viewing competitive pricing as one analytical input for making data-driven pricing decisions, not the sole factor dictating pricing. Combining it with value-based, cost-based, and optimization approaches provides a more comprehensive framework for maximizing profitability.

With the right balance of market awareness and strategic pricing best practices, competitive pricing can be a useful component of an intelligent overall pricing strategy.