Question

The financial writer Andrew Tobias described an incident that occurred when he was a student at the Harvard Business School: Each student in the class was given large amounts of information about a particular firm and asked to determine a pricing strategy for the firm. Most of the students spent hours preparing their answers and came to class carrying many sheets of paper with their calculations. Tobias came up with the correct answer after just a few minutes and without having made any calculations. When his professor called on him in class for an answer, Tobias stated: "The case said the XYZ Company was in a very competitive industry ... and the case said that the company had all the business it could handle." Given this information, what price do you think Tobias argued the company should charge? Briefly explain. (Tobias says the class greeted his answer with "thunderous applause.")

Short answer

Tobias likely suggested that the XYZ Company should increase its prices. Given the high competition and the company's ability to handle all the business it receives, raising prices could enhance profitability while potentially positioning the company's products or services as premium in the market.

Step-by-step solution

Identify the Market Conditions

The first part implies that XYZ company is in a highly competitive industry. It indicates a situation where many businesses offer similar products or services, so there is intense competition for market share.

Assess the Company's Business Volume

It is mentioned that the company has all the business it could handle. This suggests that the demand for its products or services is high and consistent; they sell all or nearly all of what they produce.

Determine the Pricing Strategy

Based on these conditions, it is plausible that Tobias inferred that XYZ Company should charge higher prices. When demand is high and equal to or greater than supply, companies typically have pricing power and can afford to increase prices.

Justify the Pricing Strategy

Higher prices could bring several benefits. Firstly, they could enhance profitability as long as the demand remains steady. Secondly, in a competitive market, higher prices might position the company's products or services as premium, potentially attracting more customers who perceive higher-priced goods as higher quality. Finally, the increased revenue could be reinvested to further improve the company's capacity or quality, securing its competitive position.

Key concepts

Market Conditions

When analyzing a company's pricing strategy, the first thing to assess is the market conditions in which the firm operates. This concept encompasses a multitude of factors, including the number of competitors, the uniqueness of the products or services offered, and the overall demand. In a highly competitive market, businesses often compete aggressively for a share of the market, which can lead to price wars, thin profit margins, and the need for continuous innovation.

In the case of XYZ Company, the information indicated an intensely competitive industry. This environment typically forces companies to be keenly aware of their pricing strategies, as a slight change can significantly affect market share. In such conditions, maintaining competitive pricing is crucial, but if a company's business volume is high, as in this example, the firm may possess the leverage to demand higher prices without losing customers.

Business Volume Assessment

Understanding the business volume is essential for setting an optimal pricing strategy. If a company has reached its full capacity, also known as having all the business it can handle, it may indicate robust demand for its products or services. This assessment looks at production capacity, sales records, and customer demand patterns to determine whether the company can increase production or if it needs to optimize existing resources.

For XYZ Company, the high demand suggests that the market's appetite for its offerings is strong. Especially if the company reaches or nearly reaches its full capacity consistently, it has a clear indicator of a strong market position. Under these circumstances, the company has pricing power, which is the ability to raise prices without losing significant market share—a valuable position to be in within any industry.

Competitive Industry Analysis

Conducting a competitive industry analysis involves looking at the number and strength of competitors, market growth trends, and the overall industry health. This analysis also considers how the market reacts to price changes. It's important to understand whether consumers view products as commodities with little differentiation or as unique offerings.

In the context of the XYZ Company, which operates in a very competitive industry, a savvy competitive analysis would consider how consumers perceive its products versus others on the market. The firm has to decide whether to compete on price, quality, or another value proposition. A company in such an industry, paired with strong business, might choose to focus on quality and brand prestige, allowing for higher pricing.

Demand and Supply Equilibrium

The equilibrium between demand and supply is a fundamental economic principle that dictates the price level at which the quantity of a good demanded by consumers equals the quantity supplied by producers. In a state of equilibrium, the market is stable, and the price is less likely to experience extreme fluctuations except in the case of external shocks.

In Andrew Tobias’ example, a key insight was that XYZ Company had all the business it could handle—an indication that the demand for its offerings equaled or even surpassed its full production capacity. This scenario suggests that the company was operating at or near the demand and supply equilibrium. Therefore, it could afford to raise prices without negatively affecting sales volume—taking advantage of the economic conditions to optimize profit. When discussing equilibrium, it's crucial not to forget the power of perceived value, which can affect the price customers are willing to pay, a consideration that should be part of any pricing strategy.