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Competitive pricing is the process of setting the prices for goods and services based upon those of a competitor. Deciding whether to charge more than, less than, or the same as the competition is a major part of pricing strategy. Typically, competitive pricing is analyzed in terms of undercutting the competition, or charging a price that is below the market. There is a fine line between healthy competition and illegal anti-competitive practices, however. Business owners must take care that competitive pricing does not stray into prohibited predatory pricing.
One of the most basic decisions a business owner must make is what to charge for his company's goods and services. Theoretically, the business owner has three options. He can locate other companies that sell the same or similar products in his part of the country and align his prices with current market prices. Alternatively, he can try to distinguish his products as better than what is currently on the market and charge a premium. Finally, he can price his products lower than the market, effectively undercutting the competition.
These pricing strategies are the basis of competitive pricing. Business owners make important pricing decisions based on the relationship they want to have with their competitors. Setting prices at or above the market rarely causes a business owner any problems with other owners. Conforming to the market sets the business on a course to maintain the status quo. Setting a premium price creates a new market and requires a marketing strategy that is focused on convincing consumers of a product's unique attributes to justify a higher price.
Undercutting the competition can have various repercussions, however. This sort of competitive pricing most directly pulls customers out of the pockets of competitors. A business environment is more likely to become hostile if a new business opens that intends to use lower pricing to attract customers. Such a tactic can lead to a price war, where businesses go back-and-forth with price cuts. Price wars are beneficial to customers but are unsustainable for the businesses involved.
Governments monitor price undercutting closely. While ordinary competitive pricing is encouraged, setting prices low to drive a competitor out of business can be viewed as anti-competitive predatory pricing that makes the market more susceptible to a monopoly. Typically, if a business owner can set prices lower because of an efficiency in his business operations, it is considered simple competitive pricing. However, if a business owner uses cash reserves to sustain lower prices and raises prices once he drives a competitor out of business, the strategy will more likely be considered predatory.
Here's another question -- if you look around at gas stations in your town, you'll notice they all charge very close to the same amount for fuel. If those stations are affiliated with different oil companies, how is it competitive for them to charge all essentially the same price?
That sounds like it borders on collusion, so why isn't it considered to be just that?
The theory of competitive pricing directly benefiting consumers is precisely why "trust busters" such as Teddy Roosevelt went hard after monopolies and why the federal government still cracks down on them.
One question, however -- there are legal monopolies that are allowed to exist. Think of your local electric company, for example. Why is competition encouraged in some areas and not others?
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