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Pricing and Business Strategy

What is the relationship between the pricing point an organisation chooses for its products and its overall business strategy?

Let's start saying that to compete sustainably companies can adopt one of the following strategies: Low cost or Differentiation.

The main challenge in developing a low-cost strategy is squeezing the costs of production to the bone. An organisation can do that by standardising and consequently automating the activities required to manufacture their products.

McDonald's provides an excellent example for this. In the recent movie The Founder, you can see how Richard James "Dick" McDonald and his brother Maurice James "Mac" McDonald created a low-cost strategy in the food industry.

The following slide shows how low-cost manufacturers despite selling their products at a reasonable price, can generate higher margins, therefore higher profits, by reducing the cost of production.

The second type of strategy leading to sustainable competitive advantage is differentiation.

Companies competing through a differentiation strategy produce premium products commanding higher prices which more than justify the increased cost of production.

Creating a premium product frequently leads to increased cost of production for two main reasons: the quality of the raw material required, and more importantly the lack of standardisation and automation in the activities required for manufacturing the product.

Premium car brands e.g. Ferrari still outsourcing the productions of specific parts of their vehicles requiring the expertise and the art of local artisans; machinery can't easily replace these activities.

The following slide shows how companies competing with a differentiation strategy can generate higher margins (despite increased prices) by commanding higher prices for their products.

Competing purely on price is not a valuable business strategy.

Not only cutting prices damage the company itself (reputation, brand, credibility) but also generates retaliations among competitors. In so doing fostering a destructive competition in the industry. A head to head competition in which no company can win.

Here is an explanatory video I have created explaining the relationship between pricing and the business strategy of an organisation.

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