Price leadership occurs when a leading company in a specific industry sets the price for goods and services, then other firms in the industry match the price set by this leader. This is typically common in oligopolistic markets. In an oligopolistic market, few firms exist and can dictate the direction of prices. The price leader is usually the firm that has the largest market share or the strongest customer base due to the quality of goods. Price leadership strategies can be seen as collusion in some markets.
An example of the oligopolistic market model is the airline industry. In many countries, few airlines exist; this gives rise to a market leader who can dominate customers in the market. By setting a high price, the leader will dictate this practice to the other firms. This sets a standard price for goods, and airlines must obtain high market share through service or other incidentals, as no price advantage exists. Collusion can occur if the price leadership does not relate to an increase in operating costs.
Collusion is illegal in most countries. In order for an oligopolistic market to engage in collusion, two or more market firms must agree to set arbitrarily high prices. This forces customers to pay prices above market value and receive no extra advantage from products. Many oligopolistic markets face this scrutiny when a price leadership strategy is evident. Government agencies usually need to step in and review the business practices associated with collusion and price leadership.
The benefits of price leadership can be somewhat difficult to see. A company typically raises prices to offset higher operating costs. In the oligopolistic market model, however, higher prices can indicate more value from individual products. This quality can make it difficult for competitors to create a product with matching quality and a corresponding price. In absence of collusion, consumers expect high product quality associated with high prices.
High prices do not equal high profits. Companies with inefficient production models can suffer low profits or even losses when they cannot translate high prices to profits. Oligopolistic markets can use high prices as a barrier to entry for other companies. Companies that cannot enter the market and compete with current firms will be unable to operate effectively. This protects all firms in the current market and ensures that the price leadership set will prevent the loss of customer share to other firms.