I have experienced a number of price wars and seen the effect of others.
Each price war has been extremely damaging and the best way to survive a price war is do you best to stop it starting in the first place although sometimes, competitors are so stupid and behave so irrationally that a price war is inevitable.
Unfortunately the recession is increasing pressure on businesses to keep sales high and owners and managers can feel forced into cutting prices.
Why Do Price Wars Start?
Price wars start because:
- The market is declining and firms are fighting for a larger share of a smaller cake; or
- One (or more) firms have very aggressive growth objectives
- The price war can start by accident.
Aggressive competitors believe that they can make more money by:
- Trying to force competitors out of business because they have major cost advantages or can withstand the losses for a longer period. Once competitors leave, the aggressor believes they will have a dominant position in the market which allows them to control prices.
- They don’t understand how their own cost/volume/profit relationship works and may underestimate the cost of the product or service.
- They don't realise that if they lower prices, their competitors are likely to find out what is happening and respond. All too often strategies are considered in isolation without thinking about how competitors will react.
Price Wars Can Start By Accident
Competitors' actions are misunderstood.
Perhaps there is a temporary special offer from one competitor to turn slow moving stock into much needed cash which escalates into a series of tit-for-tat price reductions as the other competitors respond to what they perceive as an aggressive action.
Or fluctuations in market demand are not understood and firms think that competitors must be stealing their business. I have written an extensive review of the beer game and how systems thinking can help you interpret fluctuations in demand.
There is also the risk that price wars can start because of manipulation by buyers and fear based naivety of suppliers. A buyer gains by paying a lower price so an unscrupulous buyer can:
- Exaggerate the offer from a competitor by outright lying - Smith & Jones have offered us a price of £2.50 per unit when you are charging £3.30 (when their best price is actually £2.95)
- Mislead by missing out key terms - Smith & Jones have offered us a price of £2.95 when you are charging £3.30 (but they want us to order and take immediate delivery of 10,000 units - their price for the 1,000 units that you provide us with is £3.35)
There Is Usually No Winner In A Price War
There are often no winners in a price war.
A price war can destroy the profitability of an industry for many years hurting every single competitor. Many industries have found that it is much easier to cut prices than it is to increase them again afterwards.
Even customers may lose out if a product is treated as a price based commodity when there are really valuable differences in either the product or the service. As struggling competitors withdraw from the market, either voluntarily of through bankruptcy and liquidation, customers are left with less choice.
What You Can't Do To Survive A Price War
You can’t reach an agreement with competitors to fix prices to particular customers.
Cartels are illegal in the European Union, the US and many other countries.
What You Can Do To Survive A Price War
- Emphasise the extra quality or service of your offering – don’t allow the customer to that the product or service is a commodity and that all competitive products are equal so that price is all that matters
- Remind the customer of the risks in taking a low cost option
- Create a low cost, lower value alternative product of your own
- Work together to take costs out of the transactions. Recognise the difference between saving the customer money and your cutting your prices.
- Lower prices through a rebate scheme that rewards extra volume and not just promises of extra volume.
- Re-align your price lists. Supermarkets have low prices on the staple products like bread but make their margin on the extras that people buy. Can you use loss leaders to keep customers who will buy premium priced items out of convenience.
- Make it difficult to compare prices – e.g. mobile phone tariffs - although makes it difficult to win customers on price as well.
The Risks Of Buying From The Cheapest Competitor
Price is often used as an excuse for changing suppliers but it can be a disguise a service problem or general dissatisfaction with the customer supplier relationship.
Alternatively the customer may take for granted the customer service you provide and believe that is the industry norm when your service and dissatisfaction with that of your competitors wins you business elsewhere.
So make sure that the customer is aware of the risks of buying from a cheaper competitor:
- What will the customer lose that he takes for granted from you?
- What short cuts/cost savings must the competitor have made to sell at this price profitability? How will this impact on the customer?
- Why is the competitor so desperate to get extra business? Is this a last desperate attempt to win enough volume to stave off financial collapse and if that happens, where will that leave the customer.
Signalling To Competitors
Collusion is illegal and the punishments are high.
But that doesn't mean that there can't be some kind of communication with competitors - perhaps with the market in general via the trade press, through customers (although you have to be careful that the true message is passed on) and through trade associations.
It's what business strategists call signalling - making clear what is happening in the market and what you are doing so that the competitors are better informed and not left to make up their own minds.
Some of this signalling is counter-intuitive but it has to be to fight the idea that "more sales equals more profit".
If the market is in severe decline, like the housing and car markets at the moment in the UK, it makes it much easier for business owners to understand why their sales volumes are down by 30%.
The market leader needs to make sure that they are not caught up in a bravado exercise for their own public relations - the industry is down a long way but we are selling more. That kind of statement signals to competitors that their volume is being "stolen".
The same education is needed to explain the impact of the Beer Game and how de-stocking along the supply change exaggerates the impact of demand changes at the other end.
And if you are having a sale to sell off excess stocks, signal the fact that the sale is limited in quantity and duration. It may cause competitors some short term pain but it won't last long.
If there is a danger of a price war, the trade can be educated on the dangers of cutting price and the devastating effect on profit of just moving the purchase volumes around.
The aim of effective signalling is to stop the price war happening.
The Signals Of An Aggressive Competitor
Sometimes a competitor will signal an aggressive move. "It is our intention to grow market share to 40% and we will do whatever is necessary to get it there."
This type of signal gives competitors a problem and a price war may be inevitable.
Is the threat credible? Does the competitor have the financial muscle to back up the intention?
Will the expansion stop at 40% or will it then be 50%, then 60%...?
If you are going to have to fight, it may be better to fight the battle early.
What will it take to stop the competitor and is the fight worthwhile or should the business withdraw from the market?
It is better to withdraw early than suffer huge losses and being forced out.
Disciplining The Aggressor In the Price War
Some price wars are fought in public. The market trader selling vegetables knows when his competitor has cut prices and can react immediately. The other party sees the reaction and has a choice of cutting price again, matching the price or increasing the price hoping the competitor will follow again.
Other price wars are in private.
The first the incumbent supplier may know that an aggressor is taking action is when the orders stop or a phone call comes in asking for a new competitive quote.
The choice is to match the lower price or to hold. Keep the business at a lower price, then your competitor has not gained but you have lost profit - and the customer may now be very marginal.
But do you leave it there, or should you try to rap the competitor across the knuckles?
It's another signalling issue.
If you know the industry well, you can go to your competitors customers - not all of them but enough to get the point across - and either
- Submit a lower price yourself and threaten the established competitor's volume.
- Discover the prices offered by your competitor and make their customers aware that the firm is aggressively offering new customers deals which may be far better than given to existing customers.
It's one thing to try to increase profit by getting extra profit by winning your competitors customers on price but it is another to see the profit on the established business damaged.
What Are Your Thoughts On Price Wars?
Have you found yourself caught in a price war?
What happened and how did you get out of it?