Price war
Encyclopedia
Price war is a term used in economic sector to indicate a state of intense competitive rivalry accompanied by a multi-lateral series of price reduction. One competitor will lower its price, then others will lower their prices to match. If one of them reduces their price again, a new round of reductions starts. In the short term, price wars are good for consumers, who can take advantage of lower prices. Often they are not good for the companies involved. The lower prices reduce profit margins and can threaten their survival.
In the medium to long term, they can be good for the dominant firms in the industry. Typically, the smaller, more marginal, firms cannot compete and must close. The remaining firms absorb the market share of those that have closed. The real losers then, are the marginal firms and their investors. In the long term, the consumer may lose too. With fewer firms in the industry, prices tend to increase, sometimes higher than before the price war started.
But if it seems that it is a long-term move then there are many possible reactions:
markets prices can become 'sticky' because if the price rises, competitors will not follow the rise. So the merchant will lose its market share to its competitors on lower prices. But if the price falls, other players will merchants will follow suit if they can. At some point, merchants find that they can not gain profit if they cut the price further— so the sticky price remains.
Price stickiness is extremely common among large supermarket chains and prices, especially for commodities, tend not to vary much between them. Many of the supermarkets monitor price changes in other supermarket chains and vary their prices accordingly until they reach the point where any further decrease in their price will affect profits.
In the medium to long term, they can be good for the dominant firms in the industry. Typically, the smaller, more marginal, firms cannot compete and must close. The remaining firms absorb the market share of those that have closed. The real losers then, are the marginal firms and their investors. In the long term, the consumer may lose too. With fewer firms in the industry, prices tend to increase, sometimes higher than before the price war started.
Causes
The main reasons that price wars occur are:- Product differentiationProduct differentiationIn economics and marketing, product differentiation is the process of distinguishing a product or offering from others, to make it more attractive to a particular target market. This involves differentiating it from competitors' products as well as a firm's own product offerings...
: Some products are, or at least are seen as, commodities. Because there is little to choose between brandBrandThe American Marketing Association defines a brand as a "Name, term, design, symbol, or any other feature that identifies one seller's good or service as distinct from those of other sellers."...
s, price is the main competing factor. - Penetration pricingPenetration pricingPenetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. The strategy works on the expectation that customers will switch to the new brand because of the lower price...
: If a merchantMerchantA merchant is a businessperson who trades in commodities that were produced by others, in order to earn a profit.Merchants can be one of two types:# A wholesale merchant operates in the chain between producer and retail merchant...
is trying to enter an established market, it may offer lower prices than existing brands. - OligopolyOligopolyAn oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι "few" + πόλειν "to sell". Because there are few sellers, each oligopolist is likely to be aware of the actions of the others...
: If the industry structure is oligopolistic (that is, has few competitors), the playersPlayer (game)A player of a game is a participant therein. The term 'player' is used with this same meaning both in game theory and in ordinary recreational games....
will closely monitor each others' prices and be prepared to respond to any price cuts. - Process optimizationProcess optimizationProcess optimization is the discipline of adjusting a process so as to optimize some specified set of parameters without violating some constraint. The most common goals are minimizing cost, maximizing throughput, and/or efficiency...
: merchants may incline to lower prices rather than shut down or reduce output if they wish to maintain the economy of scale. Similarly, new processes may make it cheaper to make the same product. - BankruptcyBankruptcyBankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
: Companies near bankruptcyBankruptcyBankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
may be forced to reduce their prices to increase sales volume and thereby provide enough liquidity to survive. - Predatory pricingPredatory pricingIn business and economics, predatory pricing is the practice of selling a product or service at a very low price, intending to drive competitors out of the market, or create barriers to entry for potential new competitors. If competitors or potential competitors cannot sustain equal or lower prices...
: A merchant with a healthy bank balance may deliberately price new or existing products in an attempt to topple existing merchants in that market. - Competitors: A competitor might target a product and attempt to gain market share by selling its alternative at a lower price. Some argue that it is better to introduce a new rival brand instead of trying to match the prices of those already in the market.
Reactions to price challenges
The first reaction to a price reduction should always be to consider carefully. Has the competitor decided upon a long-term price reduction? Is this just a short-term promotion? If it is the latter, then the reaction should be that relating to short-term promotional activity, and the optimum response is often simply to ignore the challenge. Too often, price wars have been started because simple promotional activities have been misunderstood as major strategic changes.But if it seems that it is a long-term move then there are many possible reactions:
- Reduce price: The most obvious, and most popular, reaction is to match the competitor's move. This maintains the status quoStatus quoStatu quo, a commonly used form of the original Latin "statu quo" – literally "the state in which" – is a Latin term meaning the current or existing state of affairs. To maintain the status quo is to keep the things the way they presently are...
(but reduces profits pro rata). If this route is to be chosen it is as well to make the move rapidly and obviously - not least to send signals to the competitor of your intention to fight. - Maintain price: Another reaction is to hope that the competitor has made a mistake, but if the competitor's action does make inroads into a merchant's share, this can soon mean customers lose confidence and a subsequent a loss of sales.
- Split the market: Branch one product into two, selling one as a premium and another as a basic. This effective tactic was notably used by Heublein, the owner of the SmirnoffSmirnoffSmirnoff is a brand of vodka owned and produced by the British company Diageo. The Smirnoff brand began with a vodka distillery founded in Moscow by Pyotr Arsenievich Smirnov , the son of illiterate Russian peasants. It is now distributed in 130 countries.Smirnoff products include vodka, flavored...
brand of vodkaVodkaVodka , is a distilled beverage. It is composed primarily of water and ethanol with traces of impurities and flavorings. Vodka is made by the distillation of fermented substances such as grains, potatoes, or sometimes fruits....
). - React with other measures - Reducing price is not the only weapon. Other tactics can be used to great effect: improved quality, increased promotion (perhaps to improve the idea of quality).
Avoiding price wars
Avoidance is by far the best policy, but it is advice which may not always be taken if the benefits seem attractive (which they may also be to competitors).Price stickiness
In an oligopolyOligopoly
An oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι "few" + πόλειν "to sell". Because there are few sellers, each oligopolist is likely to be aware of the actions of the others...
markets prices can become 'sticky' because if the price rises, competitors will not follow the rise. So the merchant will lose its market share to its competitors on lower prices. But if the price falls, other players will merchants will follow suit if they can. At some point, merchants find that they can not gain profit if they cut the price further— so the sticky price remains.
Price stickiness is extremely common among large supermarket chains and prices, especially for commodities, tend not to vary much between them. Many of the supermarkets monitor price changes in other supermarket chains and vary their prices accordingly until they reach the point where any further decrease in their price will affect profits.
See also
- biddingBiddingBidding is an offer of setting a price one is willing to pay for something. A price offer is called a bid. The term may be used in context of auctions, stock exchange, card games, or real estate transactions....
- marketingMarketingMarketing is the process used to determine what products or services may be of interest to customers, and the strategy to use in sales, communications and business development. It generates the strategy that underlies sales techniques, business communication, and business developments...
- monopolyMonopolyA monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
- oligopolyOligopolyAn oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι "few" + πόλειν "to sell". Because there are few sellers, each oligopolist is likely to be aware of the actions of the others...
- penetration pricingPenetration pricingPenetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. The strategy works on the expectation that customers will switch to the new brand because of the lower price...
- pricingPricingPricing is the process of determining what a company will receive in exchange for its products. Pricing factors are manufacturing cost, market place, competition, market condition, and quality of product. Pricing is also a key variable in microeconomic price allocation theory. Pricing is a...
- production, costs, and pricingProduction, costs, and pricingThe following outline is provided as an overview of and topical guide to industrial organization:Industrial organization – describes the behavior of firms in the marketplace with regard to production, pricing, employment and other decisions...