Pricing strategy in the aluminum wheel market: Hayes versus Superior

PRICING: HAYES VS.SUPERIOR

Pricing decisions

When a firm decides to change the price of its good or services, the two driving factors are usually the cost and the competition. There is hardly another reason for change the price. Either the firm does it for itself as its costs are high and revenues are not significant or it does to beat the competition and gain bigger market share. Some theorists might add a third driving force behind pricing decision i.e. customer but this one is usually not as influential as the other two or simply doesn't play as major a role as do the two other factors. (Hyatt)

In the case of Hayes, the decision to change the price of aluminum wheel is driven by competition and not the cost. The firm already enjoys very large market share and is a global leader in this area but since it is Superior that is the market leader in North America, it is only natural for Hayes to come up with strategies to gain bigger market share and superceded Superior. Pricing is however not an easy decision. A slight change in price can produce unpredictable results and a large change may not make any noticeable change in demand. This is because it is not just the price that influences a person's decision to buy or reject a product; instead there are a host of other factors that determine price elasticity of demand for a certain product or service.

Demand Forecasting

Most firms understand that a change in price will affect demand and generally this is the main reason why price is changed in the first place. However what some firms might ignore are the factors that influence demand and may assume that lowering the price would automatically raise demand. This may not be so and the firm may be in for a rude shock. It is for this reason that before price is change, a firm must prepare demand forecast. A Demand Forecast "refers to an estimation of demand for a product for a future period. Forecasting is an attempt to foresee the future by examining the past. It is forward projection of data." (Gupta) Unlike sales forecasts that focus on sales in a particular period of time, demand forecasts study the relationship between the product and its potential quantity demanded while keeping in view all the possible factors that can affect demand. As we discussed earlier, demand is affected by factors other than price and when price is being changed, these factors cannot be ignored. Let us present a brief review of those factors and discuss a few others to explain how demand forecasts help.

Factors that influence demand or price elasticity of demand:

1. The rival products, how many they are and their quality:

The more rivals you have in a market, the greater the price elasticity of demand. This means that if people have access to many substitutes, they are more likely to switch over to another product or service in case of price increase by your firm. However quality must not be forgotten. You may have 10 competitors but if only 5 are close rivals and other 5 are producing low-quality copies of a product similar to yours, you need not worry about these five and must concentrate on the five close competitors only.

2. Transaction costs are also important:

When pricing decisions are being made, the firm must take into account the transaction costs involved with customer's switching between products. This may help in better understand demand behavior of the consumer. For example when Hayes decreases the price of its aluminum wheels by say 0.5%, it need to take into account the problems or hurdles associated with customer's decision to move to its product from Superior's wheels (if there be any hurdles at all). Similarly if Hayes decides to raise the price to attract more revenues, it must consider the transaction costs associated with rival's product which may help develop a more accurate demand forecast. These transaction costs may include additional costs that need to be incurred on fine-tuning of wheels, their maintenance, any contract signed with the manufacturer etc.

PRICES

Demand forecasting thus helps a firm understand whether it should change the price or not and if yes, at what price will consumers be most satisfied. Price elasticity of demand can thus be checked with this method however errors are likely. However demand forecasts are still more reliable than sales forecasts for they study the relationship between an item and demand intent instead of simple sales forecasts based on nothing but previous sales data.

There are some other methods of forecasting demand. It is usually recommended that a firm uses more than one method to reach a close figure. A combination of methods used to estimate possible demand is likely to yield much better and accurate results than one method alone. Hayes can for example calculate demand using the market response method as well as the time-series analysis.

Conclusion:

In any case, Hayes must not forget that price elasticity of demand is dependent on many factors and doesn't merely depend on price itself. In the case of Hayes, we expect demand of remain inelastic if price is increased. This is because Hayes has very few close competitors, it has the second biggest market share in the country and it enjoys a strong global presence. A reasonable increase in the price will not affect consumer's budget significantly either and because transaction costs might be higher, the consumer would want to stick with Hayes. However irrational increase is also advised against and similarly decrease in price may also be carefully planned. This is because just as the increase will not hurt Hayes' demand, by the same measure, a slight decrease may not product any significant change in demand. Superior enjoys the same strong position in the market that Hayes does so to expect consumers to switch over to Hayes immediately after decrease in price would be unreasonable. We thus recommend that Hayes changes its price by 0.5% for short period as a promotional strategy. This will help the firm see how consumers are likely to react to a price change. Secondly it will also give Hayes an idea as to whether a permanent price change should be considered or not. Thirdly, this is a safe strategy as it will help Hayes come back to the original price as soon as it appears that the new price isn't working in the best interest of the firm. The consumers will already be expecting the firm to go back to its original price and thus there will be no negative effects of reverting to the same old price. In case of positive response, the firm can better plan its future pricing strategy. This will also give the firm an idea about consumer's preferences and its standing in comparison with its main competitor.