An article in the Harvard Business School's Working Knowledge looks at Universal Music Group's initiative to lower CD prices and comes up with some negative criticism. The article, "Low Prices = More Customers? Not Always," was written by Hermann Simon, Frank F. Bilstein, and Frank Luby. Lower prices, they argue, don't always lead to an increase in sales large enough to justify the decrease.

"Because price cuts seem to offer the easiest way to lavish special treatment on customers, companies find the temptation hard to resist. But resist they should. Proactive price cuts don't make you different, nor do they make you better off. They make you poorer, unless you have the evidence, the data, and the math to prove otherwise."

The article features a case study of UMG's JumpStart program, which dropped wholesale prices of most CDs by 25-30%. Market share was gained, but profit dropped. Why? Not all retailers went along with the program, and sales didn't increase enough to cover the drop in price. The Working Knowledge article points out that a lower margin product is also liable to lose shelf space to other products.

"UMG also fell victim to the law of unexpected consequences. In our experience, managers often neglect to ask the question of whether their price changes will contaminate their future dealings with distributors and customers. Nor do they ask how someone could use their price cut as a weapon against them. The New York Times reported that the cut in suggested retail prices, combined with a less steep cut in wholesale prices, could cause retailers to shift shelf space away from CDs to other products. At the time of the price cuts, Wal-­Mart had already planned to reduce the space it devoted to music by 15 percent because of slow sales and low profits, the story said. UMG also shifted its marketing dollars away from in-­store promotions and toward advertising directly to consumers. This move could accelerate the demise of smaller and specialty chains. These developments are rather ironic when you consider that Doug Morris, Universal Music's CEO and chairman, said upon announcing the price cuts that 'we are making a bold move to bring people back to music stores.'"

The article's recommendations after the jump.

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