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Price Wars
Summary:
Price wars have plagued industry after industry in recent years. Indeed, price wars must be avoided like the plague! More often than not, there are no winners, only losers. The effects of price wars are not only severe but also enduring.
Price wars can lead to a severe erosion of profits. Unless there is a significant cost advantage, for the company introducing the price cut, a price reduction will lead to retaliation by competitors. So dropping prices normally does not lead to an increase in market share. Instead it leads to a sharp drop in profits.
Price wars also shape customer expectations. Research indicates that the lowest price people pay for a product or service is remembered longest, and becomes their reference point. Driving down prices to unreasonable levels, has a dramatic influence on a customer's perception of what is a "reasonable" price long after the war ends. Price wars also divert the attention of customers away from product benefits towards price. That is usually bad for the industry.
Many of the justifications given by managers for entering a price war are untenable. The claim that weak competitors can be knocked out through a price war is weak. Indeed, there is sufficient empirical evidence to indicate that price wars are not guided by any logic. They tend to get emotional and continue long after it has become economically unviable to offer these products at such low prices.
As Robert A. Garda and Michael V. Marn, point out, price wars usually occur by accident than by design. Sometimes, companies do embark on a price war, as part of a deliberate, well planned strategy. Such a strategy would make sense if the company has invested in a new technology or developed a new process that slashes costs. The company may then attempt to lower its prices to gain share and preempt competitors. The giant retailer, Wal-Mart,