How to Win a Price War: A Guide Towards Healthy Market Competition
A price war is every manager’s worst nightmare. Price wars are increasingly common in businesses and unusually fierce. So how can you remain competitive without entering into a price war? In other words, how to win a price war?
Business leaders know for a fact that pricing has a more serious impact on the bottom line than any other item on a business’ income statement. On average, a 1% reduction in price can cut operating profits by up to 12–15 per cent for companies.
Competing repeatedly and aggressively on price can harm the future of businesses. Meaning, it leads to a serious decline in financial performance.
Indeed, most companies find themselves in commodity traps when entering and participating in price wars. Businesses also suffer from considerable low profits, and smaller competitors find it hard to stay in business. Let alone the negative perception and impact a sudden price change has on customers.
A lot of products have seen dramatic cuts in price; with many low ball offers resulting as a direct consequence of a price war. The flat-screen televisions are a great example where costs have dramatically dropped in the last 10 years after serial price wars in the electronics and retail industries.
Now, it’s an everyday occurrence for electronics companies to compete with small profit margins due to yearly price wars. But it didn’t start out this way.
In this article, we will discuss the problem of price wars. We will also tackle the subject of how it impacts businesses and their future profitability. In addition, we will provide the pros and cons of entering into a price war.
We will argue that it’s possible for a company to win a price war by leveraging a specific set of strategic capabilities. But, really, to win a price war you need to know what you are doing and have the expertise to reframe a price war to growth. By the end of this article, you will know the techniques on how to win a price war in the best way possible.
Entering into a Price War
Price wars usually happen in industries where there is both heavy competition and various comparable products. Given these conditions, there is a large motivation for a rival business to cut prices as a means to gain a greater share of the market. Competitors are oftentimes forced to emulate and reduce the prices of their products as well. From here, the downward spiral begins.
Businesses tend to pursue price wars because they want to destabilise their competitors. But they also enjoy the immediate uplift they get in sales and revenue from dramatically lowering prices.
However, because each product is sold at a lower price, businesses soon experience a sharp decrease in profits. Often, the uplift in volume does not recoup the profit loss created by the sudden price cut.
What’s more, the uplift in revenue is only short-lived as most rival businesses (especially smaller independents) do not have the lean manufacturing capability to keep them in the price war.
Subsequently, it is common to find one or more of the rival businesses usually comes to a point where they can’t reduce their prices any lower. Or else, they risk losing profits and possibly harming the long-term feasibility of the company. Businesses with little financial resources may even go out of business.
Back in 1999, the major players in the long-distance phone business — Sprint, MCI and AT&T were in a price war. In July, Sprint offered a rate of 5 cents per minute for nighttime long-distance calls. One month after, MCI matched Sprint’s off-peak rate.
Later that same month, AT&T cut its long-distance rates to 7 cents per minute all day for a monthly fee of $5.95. On the day of the announcement, AT&T’s stock dropped by 4.7%. MCI’s dropped 2.5% and Sprint’s fell 3.8%.
The main weapons the players brought to the competitive market were: Price reductions, free calls, and per-second billing. Brand equity, service, quality, and other nonprice factors that might add value to their product or service were not really tackled. Every competitive move they made was based on price, and every countermeasure provided was a retaliatory price cut.
As history has instilled in us, there has never been a war that did not cause serious destruction. In hindsight, there were alternatives to have avoided it. Beyond that, however, it’s a destructive force that creates more damage than good; it is war after all.
Entering into a price war eventually harms every company or business involved in the industry. If one business cuts its prices and competitors follow by also reducing their prices as well, this tit-for-tat exchange can immediately heighten to an unsuitable point.
Pros & Cons of Price Wars
Regardless of the many case studies of price wars gone wrong, many businesses continue to participate in price wars. We ask: what are their allure and what exactly are some of the advantages and disadvantages of entering a price war. Below listed is a quick evaluation of price wars.
- Customers enjoy lower prices
- Customers also gain from additional add-on services
- Companies can gain new customers
For customers, it means better deals if they get lower prices. They can also benefit from additional products and services offered in a price war. Take, for instance, car companies. If they are engaged in a price war, a customer can buy a high-end model car at a lower price that otherwise would have been too expensive. Furthermore, a customer can get better service repair terms, such as a longer warranty or better financing, all because of a price war.
Price war “winner” companies can gain new customers as more consumers will be enticed with the low-price product or service.
- Companies may lose market share and profits especially if they lost in a price war
- It can lead to less competition and higher prices
- There are fewer choices for products and services for consumers
Nonetheless, there can also be negative effects on price wars. Consumers are left with fewer choices for products and services if a huge company drives rivals out of business because of aggressive price-cutting.
In the long run, the company gains pricing power, since there are no longer competitors. In effect, it can raise its prices anytime which can be a long-term consequence for customers.
Price war “losers” obviously will lose market share, leading to profit decline.
Price wars create economically catastrophic situations that take an extraordinary adverse effect on a company and business profitability. Regardless who wins, the players all seem to end up worse off than before they joined the fight.
Most companies wage war on the basis of low prices. However, price wars, constitute a basically different dynamic than just trying to get precedence on price.
They begin when competitors repeatedly and assertively set prices below generally accepted levels. In certain instances, businesses that begin price wars participate in self-destructive behaviour, consequently leading to downward pricing spirals that change organisation structures.
Meghan Busse of Northwestern University’s Kellogg School showed that there are no winners in price wars, theoretically speaking. The “losers” are oftentimes forced out of business, and the survivors suffer a long-term margin squeeze.
Price Wars Examples
Supermarket price wars: Coles vs. Woolworths
In September of 2019, Coles launched a sales campaign offering extensive discounts. Retail experts predicted that another supermarket price war would occur in Australia as a result of Coles brash price action in the market.
The major chain mentioned that the deals will focus on food that families usually consume. It slashed the price of whole uncooked chickens by 60 cents per kilo, chicken thighs down $1 per kilo and lunch wraps reduced by 30 cents. Coles said that they want to focus more on everyday lower prices instead of extremely slash prices for short periods only.
Subsequently, Woolworths announced the same strategy. Both major chains removed short-term specials as they desire to gain “price trust” from their customers. The huge discounting on 300 products is sure to trigger yet another price war as the two begin on a period of intensified competition from Costco and Aldi.
Queensland University of Technology retail expert Gary Mortimer said, “It’s a short-term gain for long-term pain,”. He said that price slashing or discounting ultimately leads to price wars in a market involving two or three main players.
Streaming wars: Hulu vs. Netflix
In an effort to generate revenue and maintain its content flywheel, Netflix, the market leader and established as the worldwide number one, raised the prices on most of its tiers of service.
Hulu, second to Netflix in the U.S., declared it would lower its entry-level price point. It offered ad-free tier for $2 which was less than its previous price.
Moreover, Hulu increased the price of its streaming pay-TV bundle (Hulu with Live TV) by $5. It followed price hikes from YouTube TV, Sling TV, and other competitors.
The strong player in the war is Netflix, supported by its brand loyalty and sheer scale. The rest of the players are still trying to catch up with Netflix. What makes all the difference is how they are trying to catch up.
Hulu is speculating that it can make up from the subscription revenue it is giving up from its innovative advertising offerings. In order to make that service successful through those same advertising innovations, it tried to constrain costs on its streaming pay-TV service.
Price wars are destructive to the players involved. They ruin business profits and hardly lead to a long-term edge for anyone.
Steps on How to Win a Price War
At some point, every pricing manager will be involved in a price war in their career. Every price slash is potentially the first explosion, and some discounts always lead to retaliatory price reduction that heightens into a full-blown price war.
For this reason, it’s good to consider other alternatives before beginning a price war or responding to an assertive price move with a retaliatory one. Frequently, businesses can avoid an exhausting price war by using a set of alternative strategies.
Under the right circumstances, it’s possible for a business to win a price war (as opposed to studies) by leveraging a specific set of strategic capabilities. Particularly, these involve the capability to read the business environment and how things are changing, the skills to evaluate the market to determine the trends and opportunities, and the realistic wherewithal to execute organizational changes internally across the value chain. Companies might be able to achieve success in price wars by following the five rules below:
Assert the need.
Prepare yourself if your business is continuously growing, mature, and relatively stable because sooner or later you may face a price war. Dutch retailers including AH, a subsidiary of Royal Ahold N.V. which ranked 249 in Fortune’s Global 500 list in 2013 and Laurus which operated three huge supermarket chains, including Super de Boer were losing market share to companies such as Aldi and Lidl, both Germany- based businesses. The competition was fierce.
AH was able to identify the change in customer buying behaviours by studying market data. AH was seeing fewer families from its clients and a sharp decrease in high-volume products although it was selling new and high-priced items. The CEO of AH and other executives wanted the business to be “a supermarket for everyone” though its chief competitors had cost structures that gave them a 6% edge. Then, an intense price war followed.
Choose a market.
Stay alert and be aware of trends in your industry. For companies in mature and commoditised industries, they should have analytical abilities to develop new tactics and then be able to perform them at the right time. To conserve resources, choose a target carefully.
For instance, retailers should decide whether to reduce prices on specific customer segments and products or geographically. In principle, you don’t want direct confrontations with cost leaders.
Also, there’s the question of timing: Should you slash prices when you know customers are paying attention or to do it at the same time with the launch of a rival’s new product or service?
AH announced major price reductions in October 2003. It was the most significant price cut in its 116-year history. However, it was also careful not to attack the competitors.
AH wanted to be mid-priced and service-oriented instead of positioning itself as the retailer with the lowest prices. Apparently, AH chose a middle course in hopes of limiting the price war by defining the battlefield the way it did.
Select your target.
It’s more difficult and expensive to “fight” with everyone who has the same business model as yours. It’s easier to go after one rival that appears vulnerable.
AH had to decide whether to cut prices directly or indirectly, like adjusting its service levels. It showed that AH’s market share was hurting in part because customers saw it as expensive.
So, instead of competing with discounters on prices of big brands like Coca Cola, management opted to highlight private labels, including milk and other commonly bought dairy products. To win back customers, it advertised new pricing policies, stating “From now on, your daily groceries are much less expensive.”
Stay in the fight but change your tactic.
AH targeted its own former customers instead of the rivals’. It wanted to boost market share without provoking a strong reaction and it worked. Because of the muted reaction, it allowed AH to focus on its weakest competitor: Super de Boer, Laurus’ flagship chain. The reductions in price in October 2003 that AH announced caught the industry by surprise.
To rebuild its price image, AH used its advertising dollars. It tried to strike a tone of being predictable and steady. It wanted to position itself as helping customers shop for less, instead of being assertive to its competitors.
AH showed remarkable discipline and patience over the next two years. Some analysts doubted AH’s ability to win the price war, however, AH implemented various rounds of price reductions, proving to both customers and industry experts that it was serious about its new pricing strategy.
Every week, AH gave has a different focus for its pricing strategy. For example, the first week, it targeted cheeses; the next week, cosmetics or baby food. Within four months, AH was able to win back lots of customers it had lost between 2000 and 2003.
Align profits with cost structures.
Make sure that pricing decisions are aligned with cost structures and the broader value chain. To protect its gross margins, AH made some moves early on to decrease headcount and improve operational effectiveness.
Rebuilding market share and winning back customers should go together with restructuring the business. They reduced staff at headquarters, consolidated operations of similar businesses and streamlined or, in some cases, automated activities like replenishment and merchandise ordering.
For instance, AH changed its ordering process from its 600 stores to one central office. While profits decline initially, decreasing operating costs helped AH create profits on lower revenue, that softened the blow.
Even as AH became smaller, it didn’t give up providing ways to innovate and give additional value to customers. For example, it added children’s play areas in stores. Also, it introduced new brands, such as “Choose & Cook,” aimed at making it more convenient for customers to find the ingredients they need.
When management made decisions on which policies to follow, it regularly monitored their efficacy.
When you are the industry cost leader, winning a price war may not be a major achievement. However, you don’t need to have the best cost position to start and win a price war, just like AH. What’s more important is having strategic capabilities such as analytic skills, market awareness and the ability to execute efficiently.
When you see signs of a price war emerging, the best advice is not to get involved in the first place. Understandably, that’s not easy if the price is a key part of your comparative advantage, opting not to get involved in a price war is an effortless way to let your business stay sustainable in the long run.
- Under the right circumstances, it’s possible for a company to win a price war by leveraging a specific set of strategic capabilities which involve the ability to read the business context and how things are changing, the skills to evaluate the market data to determine trends and opportunities.
- In certain instances, businesses that begin price wars participate in self-destructive behaviour, consequently leading to downward pricing spirals that change organisation structures.
- It’s good to consider other alternatives before beginning a price war or responding to an assertive price move with a retaliatory one. Frequently, businesses can avoid an exhausting price war by using a set of alternative strategies.
Price wars are devastating to the businesses involved. They wreck market share and profits and seldom lead to a long-term edge for any player.
Price war “winner” companies can gain new customers as more consumers will be enticed with the low-price product or service.
Every price slash is potentially the first explosion, and some discounts always lead to retaliatory price reduction that heightens into a full-blown price war.
Price wars create economically catastrophic situations that take an extraordinary adverse effect on a company and business profitability.
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