Dudo Y.L.

National Technical University of Ukraine «Kiev Polytechnic Institute»

“Kamikaze” – an extreme form of penetration pricing

An extreme form of penetration pricing is "kamikaze" pricing, a reference to the Japanese dive bomber pilots of World War II who were willing to sacrifice their lives by crashing their explosives-laden airplanes onto enemy ships. In the business world, the relentless pursuit of more sales through lower prices usually results in lower prof­itability. It is often an unnecessary and fruitless exercise that damages the entire dive-bombing company—not just one individual—along with the competitor. Judicious use of the tactic is advised; in as many cases as it works, there are many more where it does not.

Kamikaze pricing occurs when the justification for penetration pricing is flawed, as when mar­keters incorrectly assume lower prices will increase sales. This may he true in growth markets where lower prices can expand the total market, but in mature markets a low price merely causes the same customers to switch suppliers. In the global economy, market after market is being dis­covered, developed, and penetrated. High growth, price sensitive markets are quickly maturing, and even though customers may want to buy a low- priced product, they don't increase their volume of purchases. Price cuts used to get them to switch fail to bring large increases in demand and end up shrinking the dollar size of the market.

A prominent example is the semiconductor business, where earlier price competition led to both higher demand and reduced costs. But in recent years, total demand tends to be less respon­sive to lower prices, and most suppliers are well down the experience curve. The net result is an industry where participation requires huge invest­ments, added value is immense, but because of a penetration price mentality, suppliers can't pull out of the kamikaze death spiral.

Another risk comes in using penetration pricing to increase sales in order to drive down unit costs. Unfortunately, there are generally two reasons managers run into trouble when they justify price discounts by anticipated reductions in costs. First, they view the relationship between costs and vol­ume as linear, when it actually is exponential—the cost reduction per unit becomes smaller with larg­er increases in volume. Initial savings are substan­tial, but as sales grow, the incremental savings per unit of production all but disappear (Picture 1). Costs continue to decline on a per unit basis, but the incremental cost reduction seen from each additional unit of sale becomes insignif­icant. Managers need to recognize that experience curve cost savings as a percentage of incremental sales volume declines with increases in volume. It works great in early growth phases but not in the later stages.

Picture 1

Disappearing savings

Dollar savings per 1.000 additional units

Current volume of production

Many managers believe that sales volume is king. They evaluate the success of both their sales managers and marketing managers by their ability lo grow sales volume. The problem is that their competitors employ the exact same strategy. Cus­tomers learn that they can switch loyalties with lit­tle risk and start buying lower priced alternatives. Marketers find themselves stuck with a deadly mix of negligible cost benefits, inelastic demand, aggressive competition, and no sustainable com­petitive advantage. Any attempt to reduce price in this environment will often trigger growing losses. To make matters worse, customers who buy based on price are often more expensive lo serve and yield lower total profits than do loyal customers. Thus starts the death spiral of the kamikaze pricers who find their costs going up and their profits dis­appearing.

Penetration pricing is overused, in large part, because managers think in terms of sports instead of military analogies. In sports, the act of playing is enough to justify the effort. The objective might be to win a particular game, but the implications of losing are minimal. The more intense the process, the better the game, and the best way to play is to play as hard as you can.

This is exactly the wrong motivation for pricing where the ultimate objective is profit. The more intense the competition, the worse it is for all who play. Aggressive price competition means that few survive the process and even fewer make reason­able returns on their investments. In pricing, the long-term implications of each battle must be con­sidered in order to make thoughtful decisions about which battles to fight. Unfortunately, many managers find that, in winning too many pricing battles, they often lose the war for profitability.