Is there a silver bullet to end price wars?
It is easy to deconstruct myths about pricing, but, unfortunately, there is no silver bullet to end all price wars and increase
profitability. Pricing is a key internal process that companies need to address holistically, from strategy development to
price setting to price execution. However, we can outline three action items a company should consider to minimize the risk
of price wars:
» Quantify the impact before lowering the price: Before lowering prices by giving discounts or price promotions, every manufacturer must be able to answer these three questions:
1. How much more volume would need to be sold to reach at least the same level of profits as before the price decrease? This
can be easily calculated with the current gross margin.
2. Is price elasticity high enough to achieve those volumes? As we have seen, if the required price elasticity is far from the
elasticities typically seen in the market segment, is it realistic to believe such volume increase is possible?
3. How would the volumes and profits be affected if the competitors react and match the price decrease? Never underestimate
the ability of competitors to further undercut their prices.
Making a price decision without a clear answer to these questions is very dangerous. When competitors lower their prices,
many managers follow suit without considering the consequences on profits in the short and the long run.
Don't give away discounts without compensating for it: Sales reps or account managers frequently offer unnecessary discounts that undermine the company's profitability, as a result
of the lack of a clear commercial policy. In many cases, the best conditions are granted to the worst clients. Very often,
an analysis of discount structures surprisingly shows no correlation between the discount to a client and the volume or other
variables related to the importance of the client (see Figure 2).
Figure 2: An analysis of discount structures shows no correlation between the discount to a client and the volume or other
variables related to the importance of the client.
Another useful exercise is the analysis of the price waterfall that is illustrated in Figure 3. It shows what happens between
the list price and the net price for each customer. Startlingly, the real net price per customer is not even available on
a per-product basis in many cases. The level and structure of discounts is often not linked to the strategic importance of
the different customer segments.
Figure 3: Illustrates what happens between the list price and the net price for each customer.
Typically, a redesigned pricing process to consistently reward strategically important customers and limit discounts for underperforming
clients can increase return on sales by 200 to 500 basis points. Optimizing trade terms is a complex task, but the resulting
optimal discount structure may actually be very simple. Some of the most profitable pharmaceutical companies in Brazil are
a few local companies. They grant discounts based on a commercial policy with only a few product categories and limit discount
levels to an absolute minimum.
Rewarding good customers with higher discounts can be dangerous, as it can foster concentration of buying power, which can
then be turned against the manufacturer that offers them.
An example of a company that successfully addressed ruinous competition between its customers is AstraZeneca in Mexico. In
2009, the company came up with a disruptive solution to put an end to increasing demands for discounts from competing distributors.
A uniform retail price across Mexico was introduced, a move that favored small pharmacies and limited further concentration
of buying power. Exclusive distributors were paid a fee for service instead of working based on margins. Wal-Mart was initially
lost as a client, but now most of the MNC pharmaceutical companies have switched to this business model as well. This example
also illustrates the importance of seeking legal guidance before making any pricing decision, as implementing a similar solution
in other markets requires considering local anti-trust regulations.
Understand different patient segments and choose your battles: Significant income inequalities in emerging markets lead to different segments of patients with a broad range in terms of
willingness to pay. Identifying these segments is crucial in defining the product and price strategy of the portfolio. For
example, in China, a population segment of 13 million has an income of at least $25,000 per year; their willingness to pay
is very different from the 400 million that earn $5,000 per year or less. If manufacturers want to reach the bottom of the
pyramid, they need to assess the profit impact of potentially significant discounts on products currently serving the top
of the pyramid.
These income inequalities may justify significant price reductions that are typically not advised in mature markets. A price
cut that allows a manufacturer currently focusing on the top of the pyramid in China to reach out to the middle of the pyramid
by offering a moderate discount may pay off. However, this still requires doing the math on the volume implications of the
price change, which may vary a lot by product.
Within this context, it may be necessary to go beyond factors related to volumes and revenues and look to other considerations
such as policy and corporate social responsibility, which will ultimately contribute to the bottom line. For example, from
a short-term financial perspective, the optimal strategy for a drug may be to set a high price, reaching the very top of the
income pyramid only. However, this may lead to reactions by advocacy groups, which could eventually trigger government actions
such as price controls or even compulsory patents, with a negative impact on the bottom line.
A potential strategy to target the different segments of the pyramid is to offer a broad portfolio of clearly differentiated
products serving different patient segments. A well-executed price differentiation strategy will often yield a superior result
compared to an across-the-board cut of products currently serving the top of the pyramid.
The end game: Peace instead of Victory
By applying these three rules, manufacturers will not win price wars, but will be one step closer to not even starting them—or
at least knowing how to get out of them. Pyrrhus, the King of Epirus exclaimed after his second victory: "If we are victorious
in one more battle, we shall be utterly ruined." With this in mind, drug manufacturers in emerging markets will hopefully
no longer fight battles that they can't win.
Ken Genenz is Director of Simon-Kucher & Partners' Emerging Markets Competence Center. He can be reached at firstname.lastname@example.org
. Cova López-Sors and Rafael Alencar are Senior Consultants at the Emerging Markets Competence Center.