All war is deception: when to engage in a price war, its tactics and the fallout
Much has been written about pricing, price wars and predatory pricing, and
there have been many more column inches devoted to the strategies
required and tactics best applied when dealing with or avoiding a price war.
There are many case examples to be found involving a variety of companies and a
range of industries:
- PepsiCo, Coke and Nestle are some of the big-name companies that have slashed prices on bottled water at various times and different rounds of a price war.
- All the leading brand video game console manufacturers have engaged periodically to try lure gamers with cut-price platforms.
- Walmart and Amazon have fought a well-publicised price war over the on-line book market.
- Credit card issuers almost routinely fight price wars over 0% balance transfer cards.
- Telecom operators will campaign against each other, with claims of the highest internet speed at the lowest price.
Price wars are not solely the province of large corporations though, and they impact SMBs and smaller businesses to varying degrees, depending on their industry structure, current market trends and the company’s pricing objectives.
What is a price war?
Price war is a term used in marketing to indicate a state of intense competition followed by a series of price reductions. One player will lower its price; the others will lower their prices to match. If one of them reduces its price again, a new round of reductions will start. This is what is commonly referred to as an escalating price war.
Price wars, in general, are not good for the companies involved. The lower prices reduce profitability and can threaten an SME’s survival. The small businesses cannot compete and must close. In the long term, your customers are the losers too. If there is less competition, prices tend to increase, sometimes going higher than before the price war started (the US cable industry is one example).
What triggers a price war?
Price wars are often triggered due to the following reasons:
Excess capacity – Excess inventory in the market arising from low demand (due to adverse economic conditions), excessive production and new entrants adding further capacity in the market. All these events are sure triggers for the start of a price war among all the players. This is an established reality in Dubai,
for example, where real estate and rental costs have plummeted recently.
Comparable products – When there are a large number of comparable products in the market, it typically leads to a price war. The sector of consumer electronics, with its wide option of televisions, mobiles and laptops, is a good example.
Price elasticity – If certain players in the market believe that elasticity can be extracted from certain segments – that is, if a competitor believes that pricing is generally high in the market and that more demand could be generated from certain segments by lowering prices – then this becomes another trigger for a price war. This is the reason why a swarm of mobile phone and PC manufacturers are racing to serve the unmet needs of the bottom of the pyramid. Another good example is the introduction of the Tata Nano car in India. Now we have Bajaj, a famous manufacturer of scooters and bikes, also entering the fray.
Incompetent management – An unnecessary price war could be triggered by some managers to meet their short term targets. These incompetent managers give no consideration to the long term value destruction in the market Managers are often measured on yearly achievement of targets. Lowering prices is a surefire way to meet short term targets.
Desperation – You could also expect a price war when a large established player loses market share to a new entrant by remaining non-competitive. Conversely, a price war could be triggered by a small business desperately trying to generate incremental cash flow to survive.
High fixed cost structure – Price wars could start when competitors keep a close eye on volume to reduce the average unit of fixed cost contribution, based on the belief that discounts will generate volumes to cover their fixed costs. This is common when businesses have invested a lot in fixed assets like plant, machinery and equipment.
Low degree of industry change – A price war can happen when some players perceive that the industry structure is stale and not evolving fast enough. Some player will then start a price war as they rightly or wrongly see an opportunity to disrupt the marketplace.
Low switching costs for customers – If you are in an industry where the switching costs for a customer is low, then there will be an attempt by your competitors to try and poach your customers with a price based proposition. This is very common for the Fast Moving Consumable Goods (FMCG) sector.
Success means never letting the competition define you. Instead, you have to define yourself based on a point of view you care deeply about.”Tom Chappell, businessman extraordinaire
Dealing with the threat of price war – considering the options
Non price options
1. Compete on quality and differentiation
If your proposition is already differentiated, ensure that you communicate the incremental features, benefits and value of your differentiated offer. Most SMEs do not have the luxury of tweaking their tangible features in their proposition. However, there are ample opportunities to address the intangible aspects like superior service, deep relationships, offering special and bespoke packaging and bundling with other products and services.
This is important because if you do not have the requisite differentiation, it would behoove you to offer incremental service packages at low or no cost to compete on your main proposition. For example, in times of economic recession, hotels often drop their prices. But the Ritz-Carlton never competes on price. They are able to do this as they have positioned and delivered their proposition as the “Gold Standard”.
2. Communicate weakness and threat to your customers
Another option that SMEs have is to communicate to your buyers the inherent
risk in buying a low priced – meaning low quality – proposition. Small businesses
should also communicate to their customers the inherent long term risks to your
customers’ business if you, as the SME, is forced to exit the market.
This is an important strategic move as customers will need to be told that prices
will eventually rise as all the smaller players are forced out of the market.
3. Form strategic partnerships or alliances
You can offer exclusive deals with your main proposition, created through partnerships and alliances. For example, if you are a small business car dealer you could enter into a special deal with a major electronics distributor or airlines to offer exclusive deals and miles for any new car purchased through your dealership.
Reveal your strategic intentions and capabilities
You should reveal your strategic intention to your competitors. This could include your intent not to start a direct price war by maintaining your prices. This is important as there are many incompetent folks who are trigger happy to reduce prices.
Conversely, this could include your intention to match with everyday low prices, just in case, a desperate competitor is stupid enough to start a price war. (Frankly, this might not be tenable and sustainable for most small businesses; but this is a viable option for distributors who have the support of their principals).
As a small business distributor of some large established brands, you can also make sure that your competitors know that your costs are low (if it is low). This will effectively warn your competition about the potential consequences of starting a price war with you.
If you are reducing costs, be warned that it will adversely diminish your customers’ perceptions of quality and could well trigger an unprofitable price war.
1. Deploy indirect pricing tactics addressing the perceived value
SMEs have the option of initiating perceived pricing tactics such as segmented pricing, multiple-part pricing, volume discounts, pay per use pricing, bundling, bucketing, loyalty pricing and so on. These pricing moves allow the small business marketers to selectively cut prices for only those segments of the target customers are under competitive threat from a price war.
- Segmented pricing is when two prices are set for one product without a difference in production or distribution costs.
- Multi-part pricing is commonly used by providers of such services like car rentals, prescription drug plans and mobile phones. The general structure of these pricing schemes is a fixed access fee which sometimes entitles customers to a certain level of product use, a variable fee for additional use, and still another fee for add-on features that are priced individually and/or as bundles.
- Volume discount indicates a decrease in price when the buyer acquires a particularly large quantity of a product. A seller may offer a volume discount to entice buyers to conduct business with him/her. This reduces the profit that a seller makes on the individual product but it allows him/her to make a large a sale quickly and receive the proceeds in short order.
- Pay per use pricing does what it says: you pay only for what you use. There is no minimum fee.
- Bundling is the practice of joining related products together to sell them as a single unit. So, customers who want one must buy both. A more subtle form of bundling is to give customers who buy products together with a discount.
- Loyalty pricing comes into effect when customers actually earn discounts. For example, multi-step quantity discounts, price guarantees etc.
If you don’t get noticed, you don’t have anything. You just have to be noticed, but the art is in getting noticed naturally, without screaming or without tricks.”Leo Burnett, advertising pioneer
When would you engage in a price war?
Small businesses are strongly advised against starting a price war. However, sometimes you are compelled to do so. I would recommend that you ask the following questions before starting or engaging in a direct price war:
- Do your principal investors and suppliers have deep pockets to survive and sustain a price war?
- Do you have excess capacity or inventory that must be sold?
- Is your core business or proposition, the very essence of your survival, being threatened by a price war from a large competitor?
- Can a retaliatory price cut sway a large portion of customers back to you?
- Is there untapped elasticity in certain segments in the market that you serve? Is there a large segment of price-sensitive.
Long term implications of a price war
Changes in behavior of customers – Price wars change the behavior of customers. They teach customers to anticipate lower prices and often force them to defer their purchase in anticipation of low prices.
Perceived quality of the brand suffers – The image and positioning of your brand will suffer. Your price-cutting efforts will, in the long term, affect the perceived quality of your propositions. Often, not only the perceived value of a single affected proposition will suffer, but this has the potential for the perceived value of ALL your propositions in the market to suffer.
Triggers retaliation from affected players – A price cut will eventually wake up a giant who has been hurt. Once you harm the interest of other players, you should expect them to retaliate. Never wake a sleeping giant. Let sleeping giants sleep.
In my long career across different countries and companies, I have been involved in, or have led the start of, a price war. I can certainly assure you that in the long term it was counterproductive and the industry lost as a whole.
In this context, I would like to leave you with three thoughts from my all-time favorite military strategist. Most of you must have heard of Sun Tzu, the ancient Chinese military strategist who wrote the treatise, The Art of War. His advice:
Know the enemy and know yourself; in a hundred battles you will never be in peril.”
“All warfare is based on deception.”
“Your aim must be to take all-under-Heaven intact. Thus your troops are not worn out and your gains will be complete. This is the art of offensive strategy.”
Keep these three principles from this ancient strategist in mind before you start or engage in a price war!
JohnLincoln.one –The business growth hacker