Price War Definition
Price war refers to a commercial competition where companies, repeatedly lower prices of their goods and services in order to undercut their business rivals. Initially, one manufacturer may decide to reduce the price of its product. As a result, the rival manufacturing companies may also lower their prices so that they are at the same level. In case one of them decides to reduce the price further, a new reduction process begins again.
A Little More on What is a Price War
A price war is suitable for the dominant companies within the industry in which they operate because their chances of survival are high. On the other hand, smaller firms are most of the time not able to survive the stiff competition and so, they end up closing their businesses. When this happens, the surviving companies usually buy the shares of the closed companies.
Where price war exists, the losers are mostly the small firms and their investors. On the other hand, buyers are usually the main beneficiary of price war events. They usually take advantage of the price war to purchase goods and services at a considerably low price.
However, when it comes to companies, the price war is not as good as it decreases their profit margins. Lower profit margins definitely threaten their survival in the market.
However, if the price war goes on for a long time, then buyers will also end up losing. The reason is that as more firms close up, the remaining few in the market may decide to hike prices making products expensive for the buyers.
Price War Examples
A price war is most common among airline companies. Let’s assume that airline ABC decides to reduce their flight cost from point A to point B from $900 to $800. Airline XYZ being the rival company on the same route decides to also cut flight cost to $750. To respond to airline XYZ’s price cut, airline ABC may further reduce its flight cost from $800 to $725, and so on.
Why is Price War Common?
A price war is common where price stability has been in existence for a relatively long period, and these prices are thought to be high. One firm may then make a decision to undercut the rival businesses, in the industry by reducing the price of its products. The reason for lowering the prices is for them to be able to achieve the following:
Generally, price war escalates more quickly in an industry where businesses either barely know or do not trust each other well. Managers should be able to comprehend the price war causes and feature, to be able to make informed decisions on the following:
- When to fight a price war
- How to fight a price war
- When to back off from price war
- When to start one
How to Stop Price War
When there is a price war, companies are compelled to respond by putting in place appropriate strategies. In most cases, most companies usually retaliate by cutting prices whenever there is a price war in the market. Nonetheless, it is crucial to think of other possible strategies to be able to manage price war in the market. Below are various ways companies can stop price war:
Revealing intention to competitors
It is important that a company reveals to its competitors its intention to cut prices. For instance, it can inform its competitors of its intention of coming up with a cost structure to allow it to survive in the price war much longer where necessary. It should open up to its competitors that its intention is not to compete in the market based on price. The reason behind this strategy is to scare away competitors.
Competing strictly on non-price based measures
Another strategy is to engage in a competition that does not include a price. For instance, in case a competitor has lowered prices, and others are willing to do the same, then the company should either work with the current price or increase it. The major reason for doing this is to prevent brand image damage in the market.
Emphasize on high quality
Ensuring high quality of your products is another way a company can save itself from engaging in a price war. It will enable customers to shift their focus more on quality than on price. Meaning that there will be no need for a business to lower their product’s prices in order for customers to buy its products. Quality will be enough to attract customers their way. They could also advise customers on the dangers associated with low price products
Engaging in fight war
Another way of fighting a price war is to engage in the fight. Note that this is only if the company’s shares dominate the industry. The reason is that for a company to be able to participate in a price war, it has to be financially stable. Companies with large stakes are capable of staying long in the price war.
Planning exit strategies
Where a company is not capable of engaging in war, it can come up with several strategies that will help it to exit. When a company resolves to exit is because it knows that its chances of surviving in a price war are close to zero.
Pros of Price War
Price war comes with several benefits. Some are highlighted below:
- Price war helps to lower the annual consumer price inflation annual rate
- Price war ensures the progressive effect on consumption and real income distribution
- Price war reduces commodity prices making them affordable to buyers
Cons of Price War
Besides having several benefits, price war also has disadvantages. The main disadvantage associated with price war is a reduction in profit margins. The increased discounts reduce the revenue of those businesses engaged in a price war.
Also, competing in a price war is bound to threaten the existence of companies in the future. Those who lose in price war are most of the time forced out of business. On the other hand, those who manage to survive still experience long-term reduced profits.