A price war involves two or more competitors lowering prices in multiple rounds in an attempt to win market share. A less formal, but more telling description of this kind of competitive pricing is: "A massive transfer of wealth from sellers to buyers." Price wars make for good press, but lousy business. A recent New York Times article highlighted dueling pizza sellers in New York, whose slice prices are now $0.79 and $0.75. They're fighting a war of attrition, not only against each other, but against their own bottom lines, and against the customers who actually value the product.
If price wars are bad business, why do companies fight them?
1. Ignorance. Often, companies don’t realize what’s happening until it’s too late. For example, a medical supplier was asked to match a competitor’s quoted price, which was far lower than expected, and much lower than the supplier’s price. Panicking, the supplier dropped prices across the board. The competitor responded to what it considered a preemptive pricing move. However, the first company later discovered that the prospect had a special contract with the competitor plus some other considerations had led to dramatic discounts -- but only for this particular customer in that particular situation. There was no price cut. The cycle of retaliation transferred tens of millions of dollars to their customers, without altering market share.
2. No Strategy. When some businesses want to move product, they turn to price. When one business does this, others often follow suit. No matter who starts, once the ball gets rolling, it can be hard to stop until it smashes into something -- like everyone’s bottom line.
In addition to concern over sales, natural competitive instincts can take over. Instead of making measured decisions, we let the more primitive parts of the brain take over. We insist on “winning” at “any cost,” like the pizza sellers, now wrapped up in personal animosity more than business. However, the same thing can happen to large companies with teams of financial analysts. Remember when Sony, Samsung, et al brought enormous, high quality TVs to American living rooms? Remember how they failed to make money doing it? They were so busy competing for share in a booming market that they forgot to make money.
To avoid the fate of falling into a price war, start with a good plan. Decide how you want to respond to competitive price changes, and what thresholds of price and sales changes you can tolerate. Know your limits. Sometimes it helps to write it down, just to remind yourself to behave rationally when your competitive juices are flowing. Then use your pricing intelligence tools to understand what is happening in the market, so you can execute the appropriate part of your strategy.
3. No Differentiation. Your vulnerability to price wars is directly tied to your degree of commoditization. Pure commodities have prices that literally float on the market. If your pizza is just like your competitor’s, their price moves have a bigger impact than if you are selling gourmet pizza or burritos. The pizza price war has no bearing on the upscale Manhattan restaurant scene. Even if you are close to a commodity, you may be able to differentiate through service or other aspects of the customer experience.
Similarly, fire sales on tablets helped move inventory of HP and Blackberry tablets, but did nothing to dampen consumer enthusiasm for Apple’s iPad. Through differentiation, Apple’s computers, music players, and phones have withstood blistering price competition. They are differentiated enough that they get to do what they want, with their market, without worrying about rivals. Meanwhile, HP and Dell offer no true differentiation and have to slug it out in a battle of price and promotions.
Keep your eye on the real prize -- profitability -- and don't get sucked into price wars that can bleed your profits, often without even boosting market share. Put together a sound strategy. Don’t automatically extrapolate a few data points into a global trend. Pay attention to the information your pricing intelligence tool provides, systematically gathering data from competitive web sites, issuing alerts on an immediate level when prices change, and providing data on a long-term level to show you the big picture over time.
In Price Wars, Part 2, I'll tell you why price wars are particularly insidious for retailers, how to avoid getting into them, and when you should actually start one.
I'd like to hear your experiences with, and thoughts about Price Wars. Thanks. Reuben