Analyzing the Battleground
It’s necessary to understand why a price war is occurring – or may occur. But, it’s also critical to recognize where to look for resources in battle. It’s important to carefully analyze your customers, company, competitors, and other players within and outside the industry that may have an interest in how the price war plays out.
Customers and Price Sensitivity
A thorough evaluation of customers and their price sensitivities can provide valuable insights about whether one should fight a competitor’s price price cut with a price cut in kind or with some other strategy. Consumers are frequently unaware of substitute products and their prices, or they may find it difficult to make comparisons among functionally equivalent alternatives. For example, the cost of determining the best plan in a when customers are unsure about their calling patterns is simply too high for a low-involvement decision like long-distance/cellular phone service. A company that wanted to compete on price could chose to simplify. That’s exactly what Sprint did. It simplified its price schedule to x-cents a minute so customers could compare its rates to those from Verizon and AT&T.
Some consumers are more sensitive to quality than price, for a variety of reasons. Industrial buyers are often to pay more for on-time delivery or consistent quality because they need those features to make their businesses run smoother and more profitably. The very rational belief that poor quality can endanger one’s health is an important reason that branded drugs command the prices they do relative to generic drugs. The basic lesson is that different customer segments exhibit different levels of price sensitivity for different products at different times. Businesses that adopt a one-size-fits-all approach to pricing do so at their peril.
Company Abilities
Company factors such as cost structures, capabilities, and strategic positioning should also be examined carefully. Cost structures may be affected by by changes in technology or business practices, which in turn may tempt a company to cut prices in a manner that will trigger a price war. For example, consider the implications of outsourcing. It’s probably true that it is cheaper to buy rather than to make something in-house, because the invisible hand of the marketplace will lower the acquisition price of a product. But, the cost of manufacturing something in-house is largely sunk and fixed. When that product is purchased on the market, its acquisition cost is a variable one. In other words, integration ca lead to a cost structure with a higher fixed-cost component and a lower variable-cost component. Consequently, the company with the variable costs may be tempted to reduce prices and start a price war. But, even though the lower variable costs give the company an advantage, it should carefully consider whether a price war is consistent with its strategic posture. The company’s lower variable costs should be used to start a price war only when it will result in the neutralization or the exit of an undesirable rival.
Consider, too, the coherence of your pricing strategy and your ability to execute it. The actions of one participant engaged in a fierce price war in the utility industry is telling: The company’s senior management group ask its top manager to increase market share by by 20%, return prices to profitable levels, and stabilize them. Confronted with apparently conflicting goals, the manager chose the easiest goal – build market share – which he achieved by lowering prices, thus exacerbating the price war. The directive to the manger was confusing, his resulting action baffled competitors, and led to considerable uncertainty and increased price turbulence in the market. When the soft costs (managerial time and attention) of changing prices through a complex supply chain were factored in, the cost of the increased market share was very dear.
The essential insight that should emerge from the exercise is whether a simple price cut is the best option given one’s cost structure, capacity levels, and organizational competence.
Competitors’ Response
An analysis of competitors – their cost structures, capabilities, and strategic positioning – is equally valuable. But many unprofitable price wars happen because a company sees an opportunity to increase market share or or profits through lower prices, while ignoring the fact that competitors will respond. Market research may reveal that sales increases following a price cut justify the action, but his same research often simply ignores competitors’ price responses.
Businesses need to pay attention at the strategic level to the twin questions of who will respond and how. Smart product managers recognize the need to understand the competition and empathize with them. They project how competitors will set prices by carefully tracking historical patterns, understanding which events have triggered price changes in the past, and by tracking the timing and magnitude of price responses. They monitor public statements made by senior executives and published in company reports. And they keep their eyes peeled for activity in resource markets; competitors that acquire a new technology, labor force, information system, or distribution channel, or that form a new brand alliance, will probably make some kind of price move that will affect other players in the industry. This sophisticated environmental scanning identifies possible adversaries and their likely modus operandi.
But which competitors should you watch? Identifying competitors often has important pricing implications. For instance, a company’s direct competitors that share the same technology and speak to the same markets are important rivals. But indirect competitors that satisfy customer needs through the use if different technologies and that have completely different cost structures are perhaps the mist dangerous. Often times, price wars may be started by a company from an entirely different industry, with a radically different technology, whose cost advantages give it enough leverage to enter your market and steal your share.
The process of identifying competitors also reveals the strengths and weaknesses of current and potential rivals. This has important implications for how a company competes. It is generally wise to not stir a hornet’s nest by starting a price war with a competitor that has a significantly larger resource base or reputation for being a fierce price warrior. When analyzing your competition, carefully determine who they are, how price fits with their strategic position, how they make price decisions, and what their capabilities and resources are.
Contributors, Collaborators, and Other Interested Parties
Finally, it is important to monitor other players in the industry whose self-interest or profiles may affect outcomes. Suppliers, distributors, providers of complimentary goods and services, customers government agencies, and so on contribute significantly to the consumption experience, including product quality, the sales pitch, and after-sale service. They often wield considerable influence on the outcome of a price war – directly or indirectly. Sometimes these contributors may provide the impetus for, or may indirectly start , a price war. If you use them, keep an eye on distributors, for instance.
Sometimes contributors can help reduce price competition by enhancing the product’s value, as Intel does for computer manufacturers; assisting with marketing, as airline frequent flier programs do for credit-card companies; and limiting the exposure to competing products, as MITI has done for Japanese companies facing international competition at home. Smart managers must carefully consider other players and their interests (profit margins for suppliers and distributors, commissions for sales representatives, and so on) before starting a price war or joining one.
Where to Look for Resources in a Battle
CUSTOMER ISSUES [⇔ ⇑ ⇓]
- price sensitivity
- segmentation
CONTRIBUTOR ISSUES [⇔ ⇑ ⇓]
- Incentives of:
- resellers
- allies
- suppliers
- government
COMPANY ISSUE [⇔ ⇑ ⇓]
- cost structures
- capabilities
- strategic positioning
COMPETITOR ISSUE [⇔ ⇑ ⇓]
- cost structures
- capabilities
- strategic positioning