In Price Wars, Part 1, we said that "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." In Price Wars, Part 2, we talked about the negative effects of price wars, what management should do to check out the facts before acting, and three general pitfalls being lack of knowledge, no strategy, and no differentiation. In this post, I’ll talk about how to avoid price wars, if possible; handle them, if necessary; and look at one situation where you might consider starting one.
First, keep in mind that price wars, while damaging for any business, are particularly insidious for retailers.
Many retailers run in the red until the holiday shopping season. Each year, retailers vow that they will not compete on price, and then they panic and start discounting. If this turns into a price war, it could wipe out the whole year's profit potential. Look at Best Buy. They had a lot of problems, and trying to compete with the twin giants, Amazon and WalMart didn't help.
The best way to handle price wars is to avoid them in first place.
Rule #1 is “Don’t start a price war.” If you want to offer deep discounts, communicate clearly in press releases, Facebook posts, tweets, and other media that your competitors monitor, the reason for the discounts, and the limitations. For example, if you are clearing out old inventory, specify that sales apply to last year’s model. Remember, you are not only advertising your prices to your customers, but also to your competitors -- and not trying to agitate them. By the way, Rule #2 is “Don’t start a price war.” And Rule #3? "Don't start a price war."
Commoditized industries with a very powerful pricing lever, like airlines, use something called price signaling to realign prices without setting off price wars.
What they do is announce fare changes in advance, expecting competitors to match. If no one matches, the airline can simply cancel the changes. Knowing that your competitors are likely to match, but not beat, a price cut, reduces the value of the temporary price advantage.
You can also reduce the chances that intelligent competitors will launch a price war. Offering low price guarantees, when feasible, actually helps increase market prices, because it discourages competitors from undercutting on price. Responding rapidly to competitive price changes also removes the advantage that competitors gain from a delay in reaction time. If they cannot benefit, they may prefer to maintain higher prices. You have to be careful about defining your competitors and what constitutes a matching offer -- you don’t want to compete with Walmart on price. Just ask K-Mart.
The most effective shield against price wars is differentiation.
Even if you are selling the same product as other retailers, you don’t have to offer the same service or experience. Amazon is rarely the cheapest place to buy something online, but many consumers are willing to pay a slight premium for the trust and smooth experience. Differentiation is an easy buzz word but a difficult strategy to execute well. However, the rewards are huge. Defensible profits that competitors cannot take away by price are incredibly important. As Warren Buffett said, “The single most important decision in evaluating a business is pricing power.”
One situation where you could start a price war is when you are creating a new market and your competition can’t shoot back.
This usually involves asymmetrical competition, like when Microsoft bundled Word, Excel, and PowerPoint into one software suite, and sold the bundle for the same price their competitors were charging for individual applications. The competitors could not lower prices without destroying their profits and they had no comparable offerings to create their own bundles. Microsoft sold this suite into the rapidly growing PC market, and became the de facto standard. Most companies, however, never have the chance to launch that kind of pricing attack, and everyone should generally avoid price wars as in Rules 1, 2 and 3, above.
Price wars destroy profits and transfer wealth from producers to consumers. No one wins a price war, except the people who didn’t really care about your product. If they did, they were willing to buy before the price war. Or, as Joshua, the computer, says, in the movie, War Games… “strange game. The only winning move is not to play.”
I'd like to hear your opinion about Price Wars. Thanks. Reuben