Ford puts faith in high prices

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Ford’s promise to keep prices high is a curious one, and the way it has been phrased shows that they have failed to understand the principles of credible commitment.

It is common enough to find firms advertising that their prices have been reduced and are low. It is less common to find firms advertising that their high prices are not going to be reduced. So the new campaign by Ford UK is something of a first in business history.

The background is the following. Car prices in the UK have been generally higher than in the rest of Europe for over 20 years. The phenomenon, and its reasons, go back to the government’s disastrous policies of creating and supporting British Leyland. Leyland was a high cost, low quality producer, favoured by UK fleet buyers, anxious to pass on its costs in the UK market and unable to do so elsewhere. Since the British government was determined to buy market share for Leyland, there was little point in anyone engaging in aggressive price competition and Japanese importers – then the lowest cost firms – were discouraged from doing so by a quota.

Even as Leyland continued its inexorable decline, and Ford took over market leadership, it made little sense for anyone to rock the boat. With our market isolated by the channel and our eccentric penchant for driving on the left, prices have stayed high. So British consumers have supported the world car industry for two decades.

But the writing is now on the wall. The Competition Commission is investigating the industry and should report within months. The block exemption which allows car manufacturers to maintain effective control over their distribution network expires in 2002. The case for reviewing it is weak and, despite ferocious lobbying from manufacturers, it is unlikely that the European Commission will do so without at least attacking very restrictive conditions. Ford sales this year are down by 17%. If consumers think prices are going to fall, it makes sense for them to hold back. And if Ford is to arrest this fall in sales, there are only two courses of action available. It can cut prices now, or it can persuade consumers that prices are not going to fall.

The first is expensive, so the company must try the second. But talk is cheap. There is no reason why we should believe Ford when it says that it is not going to cut prices. Not many people will criticise it if it subsequently does.

What makes business statements credible is commitment – a demonstration that it is impossible, or expensive, not to go ahead with the declared policy. The famous examples of commitment are Alexander the Great’s burning of the boats, or Grant’s crossing of the Mississippi at Vicksburg. They demonstrated the force of their intention to fight by making it difficult for themselves to do anything else.

It seems paradoxical that you can make yourself better off by closing (or choosing?) your options. The reason these tactics work is that by cutting off your retreat you reduce the likelihood that you will need to retreat. When Japanese consumer electronic firms entered western markets, they needed to give credibility to their – then implausible – claims that their products were highly reliable. They supported their assertions by offering much more extensive warranties than had previously been offered. The real force of this was not that Sony and Matsushita would pay to fix your goods when they went wrong. It was that if they were likely to go wrong, it wouldn’t have made sense for them to have given the warranty. The best promises are effective through being given, not by being honoured.

Chrysler US, facing a somewhat similar situation to Ford UK, understood the need for credible commitments. Their dealers found unsold stocks accumulating, and the company gave rebates to help clear them. The problem was that consumers watching this process held back in the justified expectation of higher rebates still.

Chrysler’s answer was to announce that if they did give rebates, they would offer them to everyone who had bought Chrysler cars that year. The point of this offer was not just that if you bought a Chrysler car now you could be sure of a rebate. The real point was that shrewd customers – and Chrysler dealers – could know that Chrysler was not going to offer extra rebates to clear stock at the end of the sales season. The cost of doing so would simply have been too high.

Ford have made a similar offer. But there is a big difference between the Ford and the Chrysler strategies. Chrysler’s offer came in January: Ford’s as the Christmas decorations are starting to go up. Chrysler’s offer made a rebate policy prohibitively costly: Ford’s offer does no more than give the company an incentive to delay any price cut till the new year.

If Ford had promised a refund to anyone who had bought a Ford more expensively in the previous twelve months, then that would have been a convincing signal to the market that prices really were not going to come down. But it is easy to imagine the discussion of such a proposal in the Ford boardroom. What would happen, someone would have asked, if we really have to cut prices? Can we really put our necks on the line to that degree?

But the essence of a commitment strategy is to put your necks on the line. No doubt Alexander had advisers who recommended that instead of burning his boats he make some small, easily repairable hols in them – just in case he actually wanted to retreat after all.

But Alexander the Great understood why this could not work. And there is a lesson there for Ford UK. There is a difference between a commitment and a gesture, and commitments are of necessity costly. Ian McAllister, Ford’s chairman, may well be right when he says there has never been a better time to buy a Ford. But that is not what his potential customers want to know. They want to know whether there will be a better time to buy a Ford in the future. And the answer to that is almost certainly yes.

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