Price leadership definition
/What is Price Leadership?
Price leadership is a situation in which one company, usually the dominant one in its industry, sets prices which are closely followed by its competitors. This firm is usually the one having the lowest production costs, and so is in a position to undercut the prices charged by any competitor who attempts to set its prices lower than the price point of the price leader. Competitors could charge higher prices than the price leader, but this would likely result in reduced market share, unless competitors can sufficiently differentiate their products. Consequently, price leadership is most likely to occur in industries where there is minimal product differentiation.
For price leadership to exist at a high price point, there needs to be tacit collusion between the main competitors in the industry. This is not the case when price leadership drives down the price point, since competitors have little choice but to match the low prices.
Impact of Price Leadership on Consumers
Price leadership is not in the best interests of customers when the price leader sets prices higher than would have resulted under a normal level of competition. However, the reverse is usually the case, where the price leader uses its production and purchasing volume to continually drive down prices - which must be matched by any competitors who want to remain in the industry. in the latter case, price leadership can benefit consumers.
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The following are conditions under which price leadership can exist:
Collusion. Competitors tacitly agree to follow the price leadership of one company.
Overwhelming market share. If one company has by far the largest market share in the industry, its much smaller competitors have no choice other than to follow its lead on prices.
Trend knowledge. One company may be unusually good at spotting industry trends, so the other companies in the industry find it easier to follow its pricing leadership than to spend time and money to develop the same level of knowledge. This is known as barometric price leadership.
Advantages of Price Leadership
A key advantage of price leadership is that, if a company can set high price points and competitors are willing to follow those price points, then the company can earn inordinately high profits. If other firms choose to follow its lead, then price competition is squashed within the industry, allowing for higher profits among all participating competitors.
Disadvantages of Price Leadership
A potential problem with using price leadership is that the entity must monitor competitors and take reactive steps if they do not follow the company's price leadership position. Enforcement can be difficult if competitors do not want to follow the company’s lead. Another concern is that a company that successfully exercises price leadership may become complacent and not keep its cost structure sufficiently lean to allow it to still earn a profit if a price war develops.
Evaluation of Price Leadership
Being the price leader is an excellent position to be in, but there can only be one price leader in an industry, so it is an option available to few firms. Instead, most companies must concern themselves with finding a market niche that they can defend with adequate product differentiation or high service levels.