Within the last year, many industries experienced drastic pricing pressures in response to rapidly shifting buying patterns that left many markets with excess capacity (think of airline seats and hotel rooms during the pandemic when travel evaporated). If you happened to travel and needed a hotel room during that time, you likely experienced some of the lowest room rates over the past decade. Similarly, the lack of travel of any sort (commuting) led gas prices to drop to lows not seen for years. But, these price reductions were in response to shifting capacity and in many cases were little more than survival tactics. They were not really the function of a price war.
What is a price war?
A price war is when one supplier (usually) believes they can secure more market share by lowering their price. “If we cut our prices, we can drive up our sales volume,” these companies’ leaders say to themselves. The war happens when competitor responses are to lower their prices in an effort not to cede market share to the company that first lowered prices. This creates a chain reaction that often leads the entire market to lower prices. It also creates a “race to the bottom” mentality where buyers expect lower prices because they fail to distinguish between providers. Market shifts require market reactions, but a price war is usually started when significant market shifts are not in force.
For a company experiencing price pressures brought on by competitors lowering their prices (often significantly), the issue is how best to respond. There are known outcomes from participating in a price war, few of which are positive:
- The incredible shrinking profit margin: Every transaction has become increasingly transparent – and in many cases, while it’s great for consumers, this transparency is the enemy of profit margins. It’s hard to maintain big profit margins if your customers are constantly able to research prices online, compare your prices with competitors, and generally whittle away at your selling prices.
It took 7 years for Amazon to become profitable, but in that time, the entire industry experienced shrinking profits, or went out of business (Borders, Waldenbooks, B. Dalton, Crown, Barnes & Noble).
- “Temporary” price cuts tend to become “permanent:” You may damage your brand with a temporary price cut. If you try to compete on price in the short run, customers are going to be reluctant to go back to paying higher prices in the future – many companies find that it is often difficult to raise prices once customers get used to paying a lower price. And many “premium” brands find that their unique cachet disappears when their products start showing up in the bargain bin.
- You will never be the best in the world at “low prices:” Just like the old saying, “no matter how good you are at something, there’s always someone in the world who’s better than you.” In the entire world, you’re never going to be the lowest-price option. There will always be someone who is willing and able to go lower on price. We are all competing in a global market against Wal-Mart and McDonald’s and lower-priced talent in lower-wage countries; and even Wal-Mart loses out to Dollar Tree. If price is the only selling point, none of us are going to survive for long.
How to Avoid a Price War
Even during a price war, there are companies that don’t participate. These companies hold the line on pricing and yet manage to keep customers. How do they do it? They remind their customers of the value they provide. If every product or service is exactly the same, with no differentiation, then there will be no additional value to tout. But in almost every market, some companies position themselves differently and respond to customer desires differently. When these efforts benefit the customer, that represents value worth touting. Even in industries like metals, where prices are quoted universally each day, a supplier can differentiate based on their performance, whether that be consistently delivering on time, accurately, damage free, etc. The key is to remind your customers of your competitive advantages.
Ultimately, price only matters when there is no differentiation in the market – when the product is a commodity and all the options look the same. If buyers feel that they can get the same value for a lower price, they’ll take that deal. You need to make sure your customers are aware of the better value you deliver – if customers value what you offer, they will pay a higher price.
It’s not enough to say “we deliver on time.” Every competitor can say that, even if it’s not true. Therefore, it is imperative that you be able to prove your past performance history. If the value you bring comes in the form of being on time, accurate, damage free, etc., then show your performance data to your buyers.
Price War Winners and Losers
In a price war, the first winner is the customer, at least in the short term. In the long term, the customer may also wind up being the loser.
In the short term the customer gets what they perceive to be a commoditized product at lower prices. Because suppliers can often be poor at communicating their value, customers can often be surprised to learn that the product/service they viewed as a commodity, is in fact differentiated by value. And, in choosing a low cost provider, they have surrendered much of the value they relied upon.
The exact opposite is often the case for the supplier who is able to best communicate the value they bring to market. In the short term, they may end up losing some business when buyers are tempted by lower prices. The onus is then placed on the company that has “stolen” that business to convince their new low-price-buyer that they are going to get equivalent value for that lower price. Often, that is not the case.
We work with companies who have gone through price wars, and not caved in. They tell us they did lose some customers, but find that many, if not most, wind up coming back. When buyers are reminded of the value they receive in working with a supplier who is not a low cost leader, then they are sensitized to it when that value goes missing in a low cost transaction. If they are not reminded of the value, it may take them a lot longer to realize the value they’re missing.
In the end, the biggest loser in a price war is the supplier who has not done a good job of tracking and communicating their value. These companies likely have to lower their prices to keep business, and because this puts a drain on profit margins, they are often forced to cut costs as well. Unfortunately, cost cutting often happens at the expense of uncommunicated value. This further pushes the supplier down the price trap, which ultimately can be a race to the bottom.
Don’t try to compete on price; it’s ultimately a loser’s game. Instead, find out what you do better than anyone else – your unique competitive advantage. Then measure, improve, and communicate your competitive advantages.
