Price Wars: What are they, why they're a nightmare, and how to avoid them?

By Philip Huthwaite on March 23, 2015

Price War

What are they?

A price war involves two or more competitors lowering prices in multiple rounds in an attempt to win market share. Or if we look at it another way, it’s the massive transfer of wealth from sellers to buyers.Take this role-play:

Question: "How are you going to win that sale?"

Answer: "Offer the lowest price."

Congratulations, you’re giving away your profits to win sales, and in any capitalist society, you will always find someone who is willing to give away more than you. It’s a strange game, that the only way to win is to lose.

 

Why they’re a nightmare?

A price war is every manager’s worst nightmare. Like conventional warfare, it leaves lots of casualties by having a significant impact on the bottom-line of organisations. For an average company, a 1% drop in price can reduce operating profits by anything up to 15%.

Take the UK Supermarket industry, and in particular the recent price wars involving milk. Milk prices in the UK are now at their lowest level since 2007, and it has forced many farmers to simply leave the industry. In December 60 farmers exited alone, so perhaps it would perhaps be better to think of Price Wars as a Price Massacres!

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How to avoid them?

1. DO YOUR RESEARCH

Before following a price move, think about why a competitor may have changed their prices first. In the packaged goods industry, a company recently discovered the cost of not having accurate information. It misread a 10% price cut by a competitor by assuming that it was a long-term strategic repositioning of its product, but that was not the case. In fact, the competitor was responding to an FDA requirement that all nutritional information about packaged foods be reset to 6 oz. hence, the competitor was only trying to get rid of its obsolete 6-½ oz. package before launching the 6 oz. product. By misreading the intent of the price cut, the company responded with its own deep price cut, the result was a price war that destroyed industry profits for the year.

 

2. CLEARLY ARTICULATE THE RATIONALE FOR PRICE CHANGES

On the flip side, if you yourself wish to offer deep discounts, ensure the reasons are communicated clearly in press releases, Facebook posts, Twitter tweets, and other media that your competitors monitor. For example, if you are clearing out old inventory, specify that sales apply to last year’s model to avoid any confusion and in this case, price wars on newer models.

 

3. UNDERSTAND PRICE SENSITIVITY

It’s important to have good information about your customer’s level of price sensitivity. When competitors launch new products, check if it is a direct match to your own offering. Even where there are similarities, you may be surprised that your brand name for example could be more powerful and can therefore justify a higher price alone. Take a look at Harley-Davidson motorcycles. They typically charge a 25% premium when compared to similar specified bikes from other manufacturers, but customers who are purchasing from Harley, want the accompanying image when they ride. This is something that cannot be supplied by the likes of Honda or Suzuki whose bikes offer a more racing experience.

 

4. DEFINE YOUR VALUE

Eliminating your competition starts with a comprehensive understanding of your product/service and a clear definition of your own value proposition.

The questions you need to answer are:

  • What makes you stand out?
  • What do you do differently against your competitors?
  • Why should a customer pay more for your product or service?
  • Describe the disadvantages of buying from a competitor, something that your customer would consider a compromise. 

If you cannot answer these questions, then you lose the right to ask for a higher price.

 

5. MANAGE YOUR CAPACITY CAREFULLY

The single biggest cause of prices wars is industry over-capacity. Just looking at the oil industry in 2014 shows this, as increased supply has seen oil prices at pumps tumble. By contrast, the diamond industry carefully monitors supply through a few key players to ensure prices stay at a suitable level for everyone to benefit.

Capacity can be difficult to manage, so here are a few questions that may help:

  • Are our forecasts realistic?
  • Are our competitors’ forecasts realistic?
  • How much industry capacity is being added?
  • Can we diversify the use of our capacity to minimize risk when demand is down?
  • How significant a cost advantage will we have over our competitors?

By asking these questions you can avoid some of the painful lessons learned by companies, which have not done so.

 

6. BE CONSISTENT

If you have identified a price move by a competitor, it is important to respond quickly in an appropriate manner. If you’re slow to respond you will lose business. Buyers can be fickle and need to have a clear picture of what they get from each option, even if you’re sticking to your current prices and justifying why they’re higher.

 

Conclusion

Price wars are a nightmare for everyone involved. There should be a clear rationale for price drops, as rarely is it a good long-term tactic for improved profitability, and simply reduces the market size as a whole. If the market shrinks everyone loses, so share the market responsibly!

 

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