A price war happens when two or more companies in an industry compete for market share by lowering their prices. Look at it this way, every innovation eventually peaks. If two rival companies make use of the same processes and technology then there would hardly be any major difference between one company’s product and the other. When companies have reached this peak, rather than raise the ceiling, it is often easier (less expensive)  to lower the floor. 

So instead of trying to outdo each other by tweaking their products to provide additional benefits which may or may not be enough to win over the target market, they may choose to drop their prices. Faced with the option of choosing between two nearly identical products or services from two different companies, the consumers are likely going to patronize the company whose product is cheaper. 

Eventually, the rival company will be forced to lower its prices as well if it wants to retain its customers. This decision doesn’t benefit either company since it results in lower profit margins. But the price war once started is almost self-perpetuating and could continue until one company exits the market or accepts to lose its share of the market by holding down on its price (at least that’s what most people think), but we will get to that later. 

What causes price wars?

I wrote an article titled “The Power of Negotiation” where I talked about the battle for who will dominate the E-book market share. Amazon had entered a market with the idea that E-books would soon outsell hard copies but of course, you can’t just convince consumers to switch sides by simply touting how great and easy is to carry around a digital copy of a book rather than the hard copy. 

So Amazon did something that they have become quite efficient at, engaging in price wars with hard-cover resellers. By stripping the prices of E-books to less than half (in some cases) of the cost of hard copies, Amazon’s E-book prediction became something of a self-fulfilling prophecy. 

Soon, they were dominating the market and forcing brick-and-mortar stores that relied on selling hard copies out of business. Amazon uses a pricing strategy known as Loss Leader pricing and its goal is to attract more customers. And it works. Using this example, you can see why price wars happen. In a nutshell, the most common causes are;

• When a company tries to break into a new market, the company would offer a similar quality of product or service as other established market players, but for a lower price.  
• When a company wants to increase its market share, this is common among major players who want to snatch a piece of the competitor’s market share
• When a company wants to increase its profit margin. This may sound counterintuitive but the benefit of having a larger market share is more profit. However, the mechanisms of price wars often end with both companies dealing with declining market shares, at least until one company backs out. 
• When a company is on the verge of bankruptcy, disruptive pricing may help it boost liquidity. 

So who benefits from price wars?

The short answer to this question is NOBODY. I know this is not what you expected but hear me out. At the start of every price war, the consumers are clearly the ones who benefit. They have quality products or services being offered by competing companies for a fraction of the price. The companies involved in the price war most times end up without any profit for as long as they continue trying to outdo each other by lowering their prices. 

But this can’t go on forever, eventually, one company falls and the last one standing is clearly the winner. Having more control over the market share, the winner begins to increase prices sometimes higher than what they were before the price war started. 

Why? Because there is no healthy competition in the market. With that restrain removed, the Winner can decide to increase their prices as much as they want since they are the only players in the market, and the consumers who once enjoyed the benefits of the price war, now see themselves as the losing side. 

The consumers who (in some cases) would now have to pay more than the usual price for the product would develop a negative perception of the winning company. Especially when there is no alternative in the market. Being that a company’s brand image plays an important role in its success, you can immediately see why any victory earned through this means is a pyrrhic victory. 

Amazon As A Case Study Of The Negative Impact of Price Wars 

Again, let's look at our best case study, Amazon. A renowned e-commerce giant, Amazon is not only known for its low prices and multiple options but also for its dirty antics in maintaining absolute control over the market. 

This anti-competitive and monopolistic behavior may have earned the company massive profits over the years, but it is not without its downsides. An article published by the New York Times in 2020 claims that most merchants on Amazon are peddling fake products. 

But this is not the only media company that has it out for Amazon. The Wall Street Journal. Verge and even CNBC have all carried out investigations that revealed potentially damaging information about the company. From selling contrabands to shipping expired products. 

These issues have caused major brands like Nike, Birkenstock, Ikea, and Popsockets to pull out of the platform. Their reason? The uncontrollable proliferation of Knockoffs. The price Amazon has to pay to maintain its aggressive pricing strategy of underselling its products is that it opened its doors to cheaper alternatives. 

The quality of products sold on Amazon is in question here. But that is just one side of the matter. Another problem Amazon has to deal with is the lawsuits filed against the company for its uncanny practices. 

The Federal Trade Commission and 17 state attorneys recently filed a lawsuit against the e-commerce giant for engaging in “a course of exclusionary conduct that prevents current competitors from growing and new competitors from emerging. By stifling competition on price, product selection, quality, and by preventing its current or future rivals from attracting a critical mass of shoppers and sellers, Amazon ensures that no current or future rival can threaten its dominance.”

You can read all about the lawsuit here.  

Strategies for winning price wars

The question now is, if you find yourself in the crosshairs of companies like Amazon, who would do anything to stifle the competition including operating at a loss, what do you do? Here are three strategies that might help. 

Differentiate your Product

In the heat of competition, companies try so much to outdo themselves that they end up with nearly identical products or services. This is common in industries where there can hardly be any trade secrets. Take the airline industry as an example. If Airline X and Airline Y operate in the same country, they would both have to battle it out for the title of  “Best Airline in the country”. 

If Airline X decides to upgrade to the latest commercial jets with more leg space and generally better comfort. Airline Y can simply follow suit and upgrade its jets as well. Once again, both companies are more or less at the same level, and there is nothing to sway the customers to choose one airline from the other. 

This is the ceiling I was talking about at the beginning of this article. At this point, Airline X may decide to lower its price while still providing the same level of comfort to its customers. This will tip the scales in their favor, after all, there is nothing customers like more than paying less for quality.

You can almost guess what Airline Y will do next. Of course, they may want to match the price offered by Airline X. Ladies and Gentlemen, thus begins the great Price war. 

But, let’s take a step back and see things from a different perspective. What if Airline Y decides that instead of lowering its price, it would provide an additional service to its customers to justify paying a higher price. 

This additional service may cost them more, but the cost is nothing compared to what they stand to lose if they decide to engage in a price war. But there is more, according to PWC, customers value experience over price and even quality. 

Think about this for a second, committing to a new service may not look like a financially savvy decision at the moment, but in the long term, this provides customers with a new experience for which they may not mind paying a little more.

Diversify your income sources 

Another way to win a price war is by having several sources of income. To achieve this, a company could merge with another company in a different sector/industry or merge with one in the same industry but at a different stage in the supply chain. 

The first instance is known as market extension merger and the second instance is known as vertical merger. When this happens, the company is better equipped to handle a price war, either by waiting it out or beating its prices so low that the competition is forced out of business. 

While it stays afloat using income generated from its other investments. This strategy would better serve as a way of hedging against price wars. Because in the heat of the moment, a company might not have sufficient funds, or find another company for a merger. 

Make peace not war

If all else fails, there is one last resort and that is to shake hands and come to a compromise. Nobody benefits from war of any kind and price wars are no different. So instead of tearing each other down, why not collaborate? A single company emerging the winner from a price war may find itself facing an even stronger enemy, the government and its antitrust laws. 

Just like what is happening to Amazon. In addition to that, it could equally face backlash from the customers, after it decides to raise its prices back to a level where it becomes profitable again. After all, it has to recoup its losses. 

Knowing that this is an inevitable end, a collaboration seems like a better decision especially because it would save all parties involved millions in losses, and at the same time, give them greater control over the market. 

Conclusion

Price wars are avoidable if both parties can come to one conclusion, there is nothing to gain from it. But that’s not often the case. This happens for many reasons, an overzealous CEO, the inability of both companies to find a common ground, or wrong evaluation of the competition. Whatever the case, the best decision is to avoid price wars as much as possible, but when that is not possible, then you can either hedge against it by diversifying your sources of income, merging with another company, or having a unique value proposition. And speaking of companies, if you are interested in knowing how Amazon became the giant it is today, then click the link below. 

5 Practical Lessons You Can Learn from Amazon: The Behemoth of E-commerce

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