Please click the link below for the second and third part of this “must read” series for any small business hoping to survive a price war.
- Know your enemy – Scan your environment and know your market structure
- The art of pricing – Pricing objectives and strategies
- The art of war – all war is based on deception – how to fight a price war!
There have been a lot of articles written about pricing, price wars and war gaming, and there has also been a lot written on the strategies and tactics required to avoid and or deal with a price war.
However most of these articles are written in the context of large corporations who are often well funded and have the professional managers, who have the requisite tools and capabilities to deal with a price war. There has been few to none written for small businesses. Although the guiding principles are the same for all “for profit” companies, some of the prescribed solutions are not apt for small businesses.
Before we discuss on price wars, it is important for small businesses to reflect in a structured manner their industry structure, market trends and define and develop a purposeful pricing objective. Only then can small businesses determine their pricing strategy let alone deal with or avoid engaging in a price war.
What is a price war?
Now we come to my favorite part of this long discourse on pricing.
Price war is a term used in marketing to indicate a state of intense competition followed by a series of price reduction.
One player will lower its price, 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.
Price wars in general are not good for the companies involved. The lower prices reduce profitability and can threaten a SMEs survival.
Typically, SMEs are the losers in a price war. The small businesses cannot compete and must close. In the long term your customers are the losers too. As you can see that if there is less competition, prices tend to increase, sometimes higher than before the price war started!.(for example 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 realty 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 is 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 from certain segments 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 famous 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 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 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. These types of completion 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 would start a price war as they 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 an 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 SME’s 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. 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 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. .
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 folks who are trigger happy to reduce prices.
Conversely, this could include your intention to match with everyday low prices, just in case a stupid or 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 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 it is 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.
Price options to deal with a 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 and loyalty pricing and so on.
These pricing moves allows the small business marketers to selectively cut prices for only those segments of the target customers are under competitive threat from a price war..
Limit the theater of operations in the 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 or channel or 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 localize a price war to a limited theater 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 specific 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 end 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 would 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 pocket 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 of a price war
Change in behavior of customers – Price wars changes 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 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, not only the perceived value of a single affected proposition will suffer, but has the potential for the perceived value of ALL your propositions in the market to suffer.
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. Let sleeping dogs 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 3 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 “art of war”. As the famous military strategist said:
- “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 3 principles from this ancient sage in mind the next time before you start or engage in a price war.