What is Dominant Price Leadership?
Price leadership is a market situation in which the majority of the market players of the industry sell their products or services at a price that has been set by the market leader. Such a model is also known as a leadership solution or followership solution. Dominant price leadership is a system in which one dominant player in the market decides the price of the goods or services for everyone. The other market players simply follow the pricing of the dominant price leader. The dominant price leader is usually the biggest market player with a significant market share of over 50% of the total output. Other players are small in size, and they do not produce any significant level of output. Hence, they are not powerful enough to influence the prices prevailing in the market. They are the price takers or followers.
The dominant price leader sometimes starts acting as a monopolistic power. It disrupts the market price and may adopt predatory pricing. Because of its large size and financial power, it can withstand short-term losses. And continue to sell at prices much below their cost. As a result, the smaller firms are also under pressure to reduce their prices to stay in the market and continue to sell their products. Further, these smaller entities continue to sell at lower prices which leads them to heavy losses. And eventually forced to exit from the market.
- What is Dominant Price Leadership?
- Assumptions in Dominant Price Leadership Model
- Advantages of Dominant Price Leadership Model
- What are the limitations of Dominant Price Leadership?
- Conclusion: Dominant Price Leadership
Once they exit, the price leader again brings back prices at the regular level. It may even increase the price from earlier levels since there is no competition left in the market. And now it can charge whatever it likes without the fear of losing its market share. Hence, in the end, it may make windfall profits and rule the market.
Assumptions in Dominant Price Leadership Model
There are several assumptions in the dominant price leadership model.
One Large Dominant Firm
One of the basic assumptions of the dominant price leadership model is that there is only one large firm in the market that controls over 50% of the market share. The rest of the firms are smaller firms with limited or small market shares.
The model assumes that the large dominant player in the market is the price maker. It decides the price of the goods or services in the market. The other smaller firms are the price takers.
Perfectly Elastic Demand Curves
The demand curves of the smaller firms are perfectly elastic in the dominant price leadership model. They can sell infinitely at the price of the dominant firm. But if they try to increase the price of their product even by a bit, they will lose their entire sale to the other players in the market.
The model assumes that the products from different suppliers are homogenous. There is no difference between them in terms of quality, looks and appearance, usage, etc. The differentiation is only in terms of price.
Advantages of Dominant Price Leadership Model
The main advantages of the dominant price leadership model are as follows:
Higher Prices and Profits
The dominant price leadership model sometimes results in higher prices of goods and services in the market. This eventually results in higher profits for all the market participants. This occurs when the dominant price leader sets its offerings’ prices high. All other market players follow its pricing and benefit by making higher profits.
Higher profits in the dominant price leadership model promote investment in activities such as research and development. This helps in the development of new products and the betterment of the existing products in the market. Thus, the market participants supply better quality products and more variety which is beneficial for the consumer as well as the suppliers as it will result in higher sales volume and revenue.
Controls Price Wars
The dominant price model helps to avert price wars between multiple small market players. The products that they offer are homogeneous. Hence, the only difference is in terms of pricing. In the absence of the dominant player deciding the prices, the smaller players may start a price war between themselves. This will result in an undue lowering of prices in the market, resulting in a fall in profits or even losses for all the players.
The dominant player sets the price for everyone in the market. This helps eliminate the chance of a price war between the market participants.
Promotes Growth and Harmony in the Market
The dominant price leadership model brings every seller on the same platform regarding prices. This eliminates the chances of rivalry due to price-cutting among them. They begin to work for the betterment and growth of the market as a whole.
What are the limitations of Dominant Price Leadership?
There are several limitations of the dominant price leadership model.
High Prices for Consumers
Often, the consumers are at a loss if the dominant price leader sets a higher than usual price of the goods or services in the market. The entire market will follow the leader and charge a high rate for their offerings. The consumer does not have the bargaining power to lower the prices and suffers.
Loss for Small Firm
The smaller firms lose out on business or are forced to suffer losses to stay in the market if the dominant price leader lowers the price of the goods or services below the cost price. The smaller firms do not enjoy economies of scale like the market leader. Hence, their cost of production is usually much higher. Also, the dominant price leader may sometimes engage in predatory pricing to drive the competition out. This may result in significant losses for the smaller players and drive them out of business in the long run.
The dominant price leadership model may promote malpractices at the end of the smaller firms who are struggling to match the prices of the leader. They may engage in unfair trade practices such as supplying under-sized or under-weight goods, tampering with quality, etc., to match the prices of the dominant price leader and still earn profits.
Conclusion: Dominant Price Leadership
The dominant price leadership model is successful if there is a scope for the small firms to sell at the market leader’s prices and still manage to earn profits. In this scenario, they will be able to sell high volumes of the product as the price is the same throughout the market. The entire market will grow and prosper. However, the consumer may be at a loss since he cannot bargain and is forced to buy the goods or services at a price prescribed by the dominant price leader.
However, in the real world, such a smooth and comfortable situation happens by exception and not by routine. There are many instances of the dominant price leader engaging in predatory pricing and throwing the smaller firms out of business. This results in creating a monopolistic situation, which can lead to the exploitation of the consumers and other stakeholders in the long run. Hence, the governments should actively control such price leadership models and bring in place strict laws and regulations to deal with any such untoward incidents.