Common agreement about price wars is that the effects are severe, enduring, and, more often than not, nobody wins. In Price Wars - Part 1, Upstream Commerce Guest Blogger Reuben Swartz wrote that companies can end up in price wars due to lack of information, having no strategy, and not exercising price differentiation. In this post, we’ll take a look at five negative effects of competitive price wars, and five precautions that management can take to avoid getting into a price war.
5 Reasons Price Wars Are A Bad Idea:
1. Dropping prices normally does not lead to an increase in market share. Cutting prices to gain market share -- as opposed to doing it because of a cost advantage -- can often permanently hurt both profits and revenues.
2. Price wars attract price buyers who may or may not be interested in making other purchases. Now you spend your time dealing with large volumes of customers who aren’t attracted to your value, distracting you from serving your best customers.
3. Price wars “spoil” your customers and create false expectations. Research indicates that driving down prices to unreasonable levels has a dramatic influence on a customer's perception of what is a "reasonable" price long after the war ends.
4. A price reduction will lead to retaliation by competitors, unless there is a significant cost advantage for the company introducing the price cut.
5. Price wars divert the attention of customers away from product benefits.
5 Steps You Can Take To Avoid Price Wars:
1. Have a good plan and stick to it. (Discussed in Price Wars - Part 1: 3 Reasons Companies Fight Price Wars).
2. Senior managers must not yield quickly when sales personnel tell them that a competitor has cut its price and they plead for an immediate matching price cut.
3. Senior managers must dig further to get additional information about the price cut. They must ascertain if the discounted price applies for only a few days of a holiday? Is it restricted to only some distributors and only to large quantities? If the answer is “yes,” an across-the-board retaliation is eminently avoidable. All players would be well-advised to use pricing intelligence to keep their fingers on the pulse of what’s happening in the market in general.
4. If you wish to steeply discount your prices, communicate clearly the reasons for the discounts, length of sale, conditions, etc., so as not to prod your competitors into retaliating.
5. Proactively communicate to your competitors the dangers of price competition.
Companies make the mistake of measuring their success by market share rather than by profitability; it also makes sense to gain market share gradually rather than aggressively. Attempts to snatch share from key rivals too quickly often lead to sharp retaliation, igniting a price war.
Price wars are avoidable for many reasons. Once they start, things can go out of control. Companies must keep their cool and not react until they understand the reason behind a competitor's price cut. Indeed, the best response to a price cut by a competitor is usually to do nothing. Even when a response is required, something other than price must be first explored.
If you decide that retaliating to someone else’s deep discount is justified, make it as limited as possible -- like restricting the price cut to a small geographical region -- which can go a long way in avoiding or at least moderating a price war.
In Price Wars - Part 3, Upstream Commerce Guest Blogger, Reuben Swartz, will tell you more ways to avoid price wars, and give an example of a situation where you might start one.