How to Survive a Price War
Entrepreneur's New Year’s Guide
What do you do when your competitors change their prices? You really have only two choices: respond or ignore them.
If the competitor’s price goes up or down, it seems intuitive that you should move your price up or down as well. But slow down and think before you act. Consider these three issues.
1. Can you segment your customers? Price segmentation is simply charging different prices to different people for the same or a similar product or service, like student or senior discounts, VIP tickets, or coupons.
Revisit customer segmentation now. Does your competitor really serve the same customers as you? If so, can you segment the market so you lower prices only to customers who really consider this competitor?
For example, when Southwest Airlines would enter a new market offering lower prices, the major airlines responded with lower prices, but not across the board. It didn’t have to lower its first-class price, nor did it have to lower its prices for loyal business customers used to frequent-flyer perks.
Notice in this example products that are highly differentiated don’t need to be discounted, nor do products that are targeted to different customer groups. If you want to be somewhat immune to competitive price pressure, focus on differentiating your products, in other words, adding value, and targeting customer segments with offerings designed for them.
2. Do your customers know? Often your customers don’t know the prices of your competitor’s products. You need to respond only if your customers know.
3. Why did they do it? Read the industry news and your competitor's press releases. Try to find out why your competitor made a price change. It may be attempting to get rid of excess inventory or trying to fill a factory. Its costs may have gone up. The price change may be temporary and not necessary for you to follow suit.
Related: Four Rules for Pricing Products
The most common cause of price wars is someone trying to increase market share, which usually means taking share from your competitors. The fastest way to do that is by lowering your prices. You reduce your price, more people choose your offering over those of your competitors, and voilà, your market share goes up.
But usually, your competitors will lower their prices in response. They're not going to sit back and let you take their share. Now both companies have the same market share as before, only at lower prices. Certainly it wasn’t worth it.
The initial aggressor may do this repeatedly (after all, the business wants to grow market share) until it finally realizes it will not “win” a price war. By then, the damage is done.
Don’t use price as a lever to increase market share unless you are certain you are in a position to win a price war.
What does it mean to win a price war? It doesn’t mean putting your competitor out of business. What it should mean is ending up with more profit when the price war is over than when it started. But now your prices are lower, so if your profits are to be higher, you must make them up in three places: increased market share, market growth and lower costs.
These are three places where you should look for percolating price wars. While price wars are always ill-advised, you need to recognize conditions in which a competitor may choose to start and likely win a price war, and to realize when you’re in a position to win the war.
- Increased market share: Significantly increased market share is possible only for companies that don’t have large market share today. A dominant company with more than 50 percent share is less likely to start a price war than a company with 20 percent share. It’s much more painful for a dominant company to initiate or respond to price decreases.
- Market growth: In many new markets, lowering prices makes the market grow more quickly. The flat panel TV market is a recent example where the prices started high and as the prices fell, more and more people purchased them. In markets where the demand curve is steep (small price changes significantly affect overall demand), driving down prices increases the number of customers, which can grow the size of the overall pie.
- Lower costs: If a company can dramatically lower its costs by increasing volume, then it’s more likely to start a price war. Although its price per unit is lower, so is its cost per unit. This could result in an overall gross margin that’s the same or even higher than before.
You don’t have to win a price war; you have to survive it. To survive, simply get out of the way. This doesn’t mean quit the business or leave the market. It means differentiate your products and segment your customers.
In the Southwest Airlines story above, American Airlines didn’t have to lower its prices on first-class tickets because Southwest didn’t offer first-class service. It was also able to charge high prices to business travelers because Southwest didn't cater to them. Know which customers are willing to pay for what you offer.
When it comes to price wars, think hard. Who in your industry could start one? How could you survive it? How could you win it? Since you never know what your competitors are thinking, always remain vigilant controlling your costs and doing the best you can at segmenting the market, portfolio pricing, and at differentiating your products.
This article is an edited excerpt from Impact Pricing from Entrepreneur Press.