All war is based on deception. So how do you fight a price war? In, John Lincoln, Vice-President – Enterprise Marketing, du, talked about knowing your enemy and pricing strategies. This month he tells us how to jump into battle.
What is a price war? Unsurprisingly, this is my favourite part in this two-part series.
A 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, and then the others will lower their prices to match. If one of them reduces their price again, a new round of reductions will start. This is what is commonly referred to as a price war.
In general, it’s not good for the companies involved. The lower prices reduce profitability and can threaten an SME’s survival. Typically, small businesses are the losers in a price war as they can often not compete and must close. In the long term your customers are the losers too. As you would have noticed, if there is less competition then prices tend to increase, sometimes to a level higher than before the price war started – for example in the US cable industry.
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 where real estate and rental costs have plummeted recently.
• Comparable products: Another sign of the advent of a price war is when there are a large number of comparable products in the market, for example, consumer electronics like mobile phones and laptops.
• 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 by lowering prices, then this is another trigger for an impending price war. This is the reason why a swarm of mobile phone and personal computer 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, another well-known manufacturer of scooters and motor cycles, entering the fray in India.
• Incompetent management: An unnecessary price war could be triggered by ill-conceived measures by 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 the yearly achievement of targets. Lowering prices is a sure fire way to meet short-term targets.
• Desperation: You could also expect a price war when a large, established player who is losing market share to a new entrant is condemned all around for being 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 type of competition 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. A player would start a price war as it rightly or wrongly see an opportunity to disrupt the market place.
• Low switching costs for customers: If you are in an industry where the switching costs for a customer is low, then there would 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.
How does a small business deal with price wars?
Non price options
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, good 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 behove 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. The Ritz Carlton, in service, never competes on price. They are able to do this as they positioned and delivered their proposition as the “Gold Standard”.
Communicate weaknesses and threats 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 long-term risks to their business if you, the small player, are 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.
Form strategic partnerships or alliances
You can offer exclusive deals with your main proposition offered 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. As the UAE is a rich and diverse market, there are ample opportunities for SMEs to seek and source alliances with major foreign principals to offer exclusive offers to their customers. The SMEs that have these strategic alliances can then bundle their main propositions with the exclusive offers attained through their strategic relationships with foreign principals.
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 stupid and incompetent competitors who are trigger happy when it comes to reducing prices.
Conversely, this could include your intention to match with everyday low prices, just in case a desperate competitor is short-sighted 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 that 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 they are indeed low). This will effectively warn your competition about the potential consequences of starting a price war with you.
Small businesses should keep in mind that that lower costs often tempt your principal brands to suggest to you to cut your prices.
One thing to keep in mind when reducing costs is that it will adversely diminish your customers’ perceptions of quality and may, by itself, trigger an unprofitable price war.
Deploy indirect pricing tactics addressing 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 small business marketers to selectively cut prices for only those segments of the market that are under competitive threat from a price war.
Limit the theatre of operations in a price war
Rather than responding with an all out price cut (which an SME invariably could potentially lose), one option is to change your customers’ choices.
This, in essence, means that a small business can limit the adverse impacts to a narrow segment, channel, sector or region.
For example, if a small business is in the retail, hospitality or transportation industry, you could avoid across-the-board price cuts, and localise a price war to a limited theatre of operation – that is to limit the war to some sectors and or regions.
Alternatively, if you are running a B2B business supplying across all vertical markets, you could limit the war to a specific channel focused on a particular vertical.
If you are a distributor of consumer electronics representing major Original Equipment Manufacturers (OEMs) in the region, you almost always have a high-end, medium-end and a low-end proposition to cater to the price sensitivity across different segments. Cutting prices across all the segments is a stupid move as most buyers of high-end consumer electronics are price inelastic. Rather than diluting the premium quality of your proposition for the high- and medium-end targets, you can have a low-priced option or an alternate package or even an alternate brand to target the low end.
When should you start or 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, therefore 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 your serve? Is there a large segment of price sensitive customers who have not adopted your proposition due to affordability factors?
Long term implications
Change in behaviour of customers: Price wars change the behaviour 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 your brand will suffer: 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, it is not only the perceived value of a single affected proposition that will suffer; this has the potential to affect the perceived value of all your propositions in the market.
Trigger 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.
The bottom line
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-favourite military strategist. Most of you would have heard of Sun Tzu, the ancient Chinese military strategist who wrote the Art of War. As the famous military strategist said:
“It is said that if you know your enemies and know yourself, you will not be imperilled in a hundred battles; if you do not know your enemies but do know yourself, you will win one and lose one; if you do not know your enemies nor yourself, you will be imperilled in every single battle.”
“All warfare is based on deception.”
“If your enemy is secure at all points, be prepared for him. If he is in superior strength, evade him. If your opponent is temperamental, seek to irritate him. Pretend to be weak, that he may grow arrogant. If he is taking his ease, give him no rest. If his forces are united, separate them. If sovereign and subject are in accord, put division between them. Attack him where he is unprepared, appear where you are not expected.”
Keep these principles in mind the next time before you start or engage in a price war. Good luck.