Rafi Mohammed

The New Way to Think About Price and Market Share

Posted on May 6th, 2008 (0 Comments)

One of the oldest axioms in business is the notion that there is a tradeoff between price and market share. Basing its logic on a classic downward sloping demand curve, the idea is that higher prices lead to fewer customers while lower prices garner more customers. So in short hand: higher prices = lower market share and lower prices = higher market share. We’ve all heard about this price/market share tradeoff and at first blush, it seems to make sense…right?

A common (and fair) critique of companies striving to achieve the largest market share is they do so at the expense of their profits – they use rock bottom prices to gain share. The “right price” (that maximizes profits) is generally higher than the one that maximizes market share. As a result, companies have to make a choice: seek the highest profits OR market share. You can have one…but not the other. Here’s my contrarian view: the right pricing strategy can result in high profits AND high market share.

I often work with eager graduate students who excitedly pitch radically new ideas to me. My first piece of advice is always the same: tell me a story that illustrates your new idea in a way that makes intuitive sense. If simple logic can support your theory, you’ve probably got something. So let me take my own advice and offer a simple yet illustrative story.

Suppose a chef at a top gourmet restaurant is deciding what prices to set for her menu. Offering $40 entrees yield high margins yet result in low market share. Conversely, dropping prices to $20 results in lower margins yet higher market share. The standard price/market share tradeoff, right?

That said, creating a pricing strategy is more than making $20 or $40 choices. The right way to think about pricing is as a series of strategies that serve (and profit from) the largest set of customers. So for a gourmet restaurant, this involves offering pricing options such as early bird specials, senior citizens’ discounts, regular prices, discounted three course meal bundles, a lower priced bar menu, and premium margined chef-table seating.

This “early bird, regular, and chef’s table” strategy maximizes both profits and market share. Lower priced options such as early bird specials keep the room full (market share) while higher margined offerings like a chef’s table reap higher margins (profit).

The notion of trading off price for market share is rooted in thinking of pricing as a two trick strategy: raise or lower prices. But pricing is so much more powerful. Adopting an “early bird, regular, and chef’s table” pricing strategy enables companies to achieve the once unthinkable goal of high profits and high market share.

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