Monday, August 2, 2010
Pricing strategies and elasticity of demand
In 1931 Pepsi-cola was facing bankruptcy. Pepsi and coca cola were both selling 6 ounce bottles at five cents each. In order to save costs Pepsi began to use 12 ounce bottles and sold it for ten cents each. This did not help much . Later they began to sell the same for 6 cents - undercutting Coca cola. Coca cola had a dominant market share and did not respond to Pepsi's price cut. The unwillingness of Coca cola to match the price cuts had implications for Pepsi's demand elasticity and ensured it success.
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ReplyDeletePepsi's decision to sell 12 ounce for ten cent instead of 6 ounce for five cent was probably a failure as they failed to realize that customers want “more for less” and not “more for more.” Paying ten cent for a single 12 ounce bottle is the same as buying two of the 6 ounce bottles and customers understood that easily. People knew that the new scheme was the same as what was being previously offered to them. Thus the initial step had no impact on customer behaviour.
ReplyDeletePepsi’s second step of selling 12 ounce for five cent was effective in attracting more sales. As per the demand theory when prices are cut consumption rises.
But the existence of Coca-cola as a profit making market leader could have had Pepsi’s price cuts to fail. Coca-cola’s unresponsiveness to Pepsi’s price cut allowed Pepsi to gain customers and come out of bankruptcy. Had Coco-cola cut its prices Pepsi may not have been able to compete and driven faster into closure? Had Coco-cola cut it prices it could have easily pushed out Pepsi. Coco-cola already had a market majority which shows that people had a greater preference for it than Pepsi. Coco-cola cutting its prices in response to Pepsi could have allowed Coco-cola to drive Pepsi out of business through a “price war.” But Coco-cola didn’t cut down its prices. Maybe it felt it would have damaged their brand name. As a well established market name a great fall in their price could deter people away from buying their product.
-Sachi Poudyal
The first method adopted by Pepsi Co., that of increasing the quantity sold per unit and also increasing the price of each unit proportionally, obviously didn't work out because the consumers were simply not getting a better deal as far as their money's worth was concerned. They did not have a big enough incentive to change their preference from Coca-cola, which had the lion's share of the market, to Pepsi.
ReplyDeleteThe second method was far more successful but also fraught with risk. When Pepsi started selling 12 ounces for 6 cents as opposed to Coca-cola’ s 6 ounces for 5 cents, consumers could get a very good deal by buying Pepsi rather than Coca-cola. Comparing the two beverages, they could save 4 cents on Pepsi for the same quantity as in Coca-cola. By applying the demand theory, one can see that since prices were brought down drastically, the demand for Pepsi would naturally increase, leading to more sales.
There are two questions that have to be answered though:
One, why didn’t Coca-cola lower its own prices? It was already a leader in the market. A reduction in prices would have been far easier for it to bear than for Pepsi, which was facing bankruptcy. If Coca-cola thought that brand name in itself would ensure its market share, then it was totally wrong. The fact that the two beverages are very common in taste worked against Coca-cola here.
Second, would everyone have rushed to buy the cheaper Pepsi after the price change? Since Coca-cola still exists, we can safely assume that this was not the case. Apart from the people who were loyal to the Coca-cola brand, i think there was also a sizable chunk of the population who would have preferred the beverage in smaller quantities. This could also be for various reasons- maybe a smaller bottle would have been easier to carry around or perhaps a person simply liked to consume smaller quantities at a time. This part of the populace must have stuck to Coca-cola since they did not wish to buy the quantity that Pepsi was selling.
Ajay Patri