Roughly half of all companies around the world think they are involved in a price war. In almost 90 percent of those cases, they think someone else started it. At the same time, losing lots of money no longer necessarily means you have lost a price war. It can mean that you have won and won big.
If you feel that the maths doesn’t add up, you are right. You have also identified a symptom of a much larger problem: most of the maths and the prevailing wisdom around price wars no longer add up.
In other words: it is time to rethink price wars
Rethinking price wars in the 21st century starts with several disruptive forces which were much less pronounced or did not exist at all a couple of decades ago, thanks to digitalisation. Think rapidly falling marginal costs, higher price transparency, and unprecedented access to customers. Think interconnectedness in terms of global trade and supply chain integration. Think shorter product life cycles, deregulation/market liberalisation, and the widespread use of algorithms instead of humans to set prices.
The business world’s views on price wars – their causes, their remedies, and even the very definition of “winning” – have not kept up with these changes. Price wars in the digital era have many more nuances, create more opportunities and risks, and inflict far more collateral damage than the prevailing wisdom would lead you to expect.
We’d like to bring you up to speed on this new era
Let’s start with three fundamental changes in the competitive environment that are impacting frequency and intensity of price wars as well as the speed at which they spread.
Radically increased price transparency and algorithm-based pricing approaches mean companies are making more pricing decisions, faster than ever before. Today, companies have unprecedented access to large quantities of pricing data (both their own and their competitors). Whole industries have emerged to serve up this data to businesses with up-to-the-minute accuracy. In many cases, the vastly increased volume and availability of data has forced companies to make more price decisions than ever before. However more data, and more automation does not always lead to better decision making.
Investors learned the hard way in 2010 that it’s possible to make bad decisions very fast in our modern, interconnected world. In the US “flash crash”, a combination of algorithm-based pricing and alleged manipulation wiped out over US$1 trillion in market value in a little over half an hour. Even though the prices and indices recovered quickly, the message was clear: algorithms and machines are not always adept at spotting the right things or spotting their own errors.
New business valuation models (and the ability for companies to stay private for longer) encourages the use of very low prices to accelerate growth. Welcome to the new world of valuations. Old boring rules about the importance of profit growth are secondary, or even suspended temporarily. These valuations are fuelled by disruptive business models, which on the surface are nothing new. Dell, Southwest Airlines, and Wal-Mart entered and then conquered markets primarily with business model innovation. The difference now is how we keep score and define success.
Companies win by earning the highest valuation, not necessarily the highest score on any conventional financial metric. Investors reward storytelling, volume, and scale, and the faster the better. This means companies can lose money and still win big, or lose big by trying to make money. Add in a product with zero marginal costs and all the incentives encourage using predatory pricing with very low prices to scale aggressively.
This new type of competition is frightening for any incumbent. The disruptors have not only changed the perception of value in the market, but also redefined the rules for success. To make matters worse, several recent studies have shown that these companies are also staying private for much longer periods. This insulates them from public scrutiny, which means they avoid both the intense quarterly pressure to make a profit and the need to justify ongoing losses in open detail.
Interconnected markets and value chains allow price pressure to spread with unprecedented speed and intensity. Investments in supply chains and business processes have made companies more efficient and more connected than ever before. Take retail. It makes complete sense for retailers to collaborate with their suppliers to maintain inventory levels in their stores using automated re-ordering systems that link stock levels between retailer and supplier. It is true ‘win-win’: goods are delivered directly to stores ‘just-in-time’ and suppliers can scale up and down their own production to meet retailer demand. In essence, what has been created is a network of global suppliers, warehouses, logistics, and retailers which look more and more like a single organisation.
All good, right? Well, maybe not. By creating a hugely efficient way of seamlessly transporting goods through the value chain, these same firms have also created incredibly efficient ways of moving price pressure through the value chain. This knock-on effect can mean that entirely unwitting players find themselves living and dying by the pricing actions of a few other players elsewhere in the ecosystem. And it is not only unidirectional. Price pressure can come from both up and down-stream and land, uninvited, at your doorstep.
What do these changes mean?
Each of these changes directly impacts how price wars start, are fought and spread. While there are many different kinds of price war, we will focus on 3 categories which have been the most impacted by these changes. Let’s now take a closer look at each of these forms of price war, their triggers, risks, implications and some suggestions on how to avoid them or wage them.
The "OOPS" price war: Imagination gone wild
“Oops” price wars happen when a company’s response to a price reduction is disproportionate (or partially automatic) or reflects a misunderstanding of a competitor’s underlying motives. Granted, companies have misinterpreted or ignored market clues forever, so on the surface the “oops” price war is again nothing new. What has changed dramatically over the last 10-15 years are the odds of making these misinterpretations. In the three most recent biannual Global Pricing Studies by Simon-Kucher & Partners, between 50 and 60 percent of companies who admitted to starting a price war claimed that it was indeed an “oops” rather than an intentional act.
In most cases, the “oops” price wars happen without any new market entrants or other shocks to the market. The risk arises instead when companies see an unexpected price cut in today’s pressure-cooker environment of information overload, fear of inaction, and rapid-fire decision-making.
If communication and information flow is particularly weak in an industry, or if price decisions are automated and largely invisible, it is no surprise that executives and managers can let their imaginations run wild as they fill in the blanks. People can easily read something into a competitive situation which really isn’t there. Someone mistakes normal price competition or a price skirmish for something bigger and grander, and the next thing you know, a price war starts with all the destructive effects. These are what we call the “oops” price wars.
Sometimes companies catch and correct these errors before they cascade into something much worse. When a computer glitch at a petrol station in Ohio accidentally posted a price of 19 cents per gallon early one winter morning in 2016, the competitor across the street interpreted the move as the start of a price war. They reacted by reducing prices to 17 cents per gallon. This miniature “oops” price war ended a few hours later when the team at the first petrol station fixed the glitch.
In other cases, a management team interprets data so narrowly that it initiates and then prolongs a price war. This can span countries and engulf an entire category. Low-growth segments of the consumer goods industry are particularly prone to this kind of “oops” price war. In part because rich data from companies such as Nielsen put price and volume transparency at a marketer’s fingertips. These marketers study their own promotional effectiveness in detail, but overlook the fact that their competitors have access to similar data and can draw similar conclusions. What might look good in isolation is terrible for the market as a whole. If a company launches a successful promotion which starts to see diminishing returns, it risks an “oops” price war when it intensifies the promotion in order to rekindle success, rather than accepting the new equilibrium. If a competitor tries to stop that price war by responding with less intensity, or not responding at all, the initiator of the “oops” price war can feel emboldened. The fresh data they see will overstate the success of the promotion and cloud the competitor’s signal. This risks prolonging a price war which should never have begun.
Two factors play a role in this. The first is the overwhelming increase in price transparency thanks to everything from basic online comparisons to smartphone technology which enables immediate price comparisons on the go. B2B competitors and customers no longer need to peruse catalogues or mystery shop to gather hints on how others in the market are pricing. The internet can overwhelm them with indications. On the B2C side, consumers can scan barcodes in a store and “shop” a similar product instantaneously, or consult aggregators for a wide range of goods and services. Competitors feel engaged in a “race to the bottom” when both professional buyers and consumers make an art and science out of finding evidence of lower prices.
The second factor is the sheer volume of prices which can permit someone to make price comparisons. Compiling them, comparing them, and interpreting them requires more analytical firepower, but also increases the chances that you still have an incomplete or outdated read on the market. Compounding these two factors are the trends toward dynamic pricing and price automation. It makes sense for companies to rely on algorithms and machine learning when no team of humans can process streams of real-time data and make thousands of split-second decisions. But these automated processes truly can take on a life of their own, as the destructive flash crash showed.
The irony with “oops” price wars is that the massive increase in price transparency often makes it harder to see what’s truly going on in a market. We have helped dozens of clients suffering from this phenomenon across a broad range of industries. Recognising the type of price competition you face begins with understanding the competitor’s motives and the stakes involved. Any price move by a competitor should raise a series of questions. Answer them reliably before you formulate your response to a price war:
- Why did the competitor make the move?
- What do they expect to gain?
- How would they respond if you matched or struck back even harder?
- What do you stand to gain or regain if you respond with a direct price cut?
- What else could you do before responding with price?
These questions sound deceptively simple, but answering them honestly and rigorously is one of the strongest deterrents to an overreaction or inappropriate response that triggers a price war. The most common motivation behind the classic 20th century price war was an attempt to grab market share, usually from a similar, established competitor. These price wars also grabbed headlines. Airlines, car makers, and telcos have waged so many high-profile wars. It is easy to think that these conscious, premeditated price wars are the predominant ones, if not the only true kind.
The fact is that companies have many reasons to cut prices beyond simply grabbing market share. One example is the desire and ability to pass on cost savings to consumers, assuming the lower cost base offers a true and sustained advantage unique to them. Such a company is using price not as a primary differentiator, but as a way to reflect an underlying form of differentiation, namely the superior cost base. Yet this may look like a share grab and send the wrong message without proper communication.
In other cases, companies may feel that overcapacity, slow or negative growth, and high market concentration put a market’s equilibrium under so much stress that someone believes a seismic shock in the form of lower prices is the only cure. These are misunderstandings or misinterpretations, and none of the parties in the price war has a clear idea of what is going on.
An “oops” war can also happen when a company uses price to offset a value disadvantage elsewhere. Let’s say a company has weaknesses in customer service. It decides it needs to cut its prices both to compensate customers and also preserve share which might be under threat. If its toughest competitor is unaware of the extent of these service issues it could mistake these price cuts for a bare-knuckled share grab and respond with its own price cuts. The war begins.
The prevalence of “oops” price wars means that a large number of businesses are still relying on inaccurate assumptions or incomplete information. This is an ominous conclusion when recognition of a competitor’s motivation is essential to understanding whether you are in a price war, what kind of price war you face, and how that war might expand and evolve.
The post-modern price war: New rules make some price wars seem rational
“You won’t find too many technology companies that could lose this much money, this quickly.”
That is how New York University professor Aswath Damodaran described the ride-sharing service Uber in an interview with Bloomberg in the summer of 2016. Uber lost an estimated $1.2 billion in the first-half of 2016. It burned up a lot of this money in a series of price wars with its competitors, as it competes both on lower fares and higher driver incentives. Yet Uber’s valuation is estimated at over $60 billion.
What explains this disconnect? We are in a new world where the “win” in price wars is different. Success in these post-modern price wars is not about the money. It is about customers and scale in order to gain financing, establish a new business model, or create a customer base to generate new and more profitable revenue streams. Uber is the current poster child for the post-modern price war, a dangerous threat to incumbents but often a rational pricing strategy for new market entrants.
In the world of unicorns, with the changes in the ways investors value companies, speed and scale matter. If scale is worth billions, then you scale, and it is perfectly rational to use price as a lever to do that. This explains the seemingly irrational idea that you win by losing money. And that strategy is terrifying for incumbents and makes no sense to them. Due in large part to digital technologies, volume-centric business models have become more commonplace. These are successfully fuelled by strategically managed lower prices rather than through the stubborn defence of higher prices. In this new era of intensified price competition, you have a battle of unequals in a market, not merely a battle of new and old. The differentiation among competitors is greater and allows price to serve as a real competitive advantage instead of a temporary form of destructive differentiation.
The business world is witnessing a shift from the old-fashioned market share grabbers to these disruptors. These are lean, low-cost suppliers whose use of low prices is a rational decision, no matter how much consternation it causes to incumbents or traditional suppliers. A price war is less an intentional act of war in this case than it is the most effective and potentially lucrative way for these firms to achieve large scale quickly. This affects not only their chances for a favourable valuation or another round of funding, but also more old-fashioned advantages such as economies of scale. We expect to see more of these as more businesses see marginal costs fall to at or near zero.
Nonetheless, victory is not a foregone conclusion. These business model and valuation wars are still hard to win, for a number of reasons. Scaling is expensive and requires funds. R&D is still essential as life cycles shorten. Even the unicorns have to balance scale with resources, as Marc Andreeson has pointed out: “It has become conventional wisdom in Silicon Valley that the way to succeed is to price your product as low as possible. [But] we see over and over and over again people failing with that [strategy] because they get ‘too-hungry-to-eat’. They don’t charge enough for their product to be able to afford the sales and marketing required to get anybody to buy it.”
Even if marginal costs are zero, total costs still have to be covered (in the mid- and long-term). No company can scale indefinitely. At some point in their business life cycle successful disruptors will become incumbents and their goals will have to change (away from scale and towards profit).
The ability to win a post-modern price war has much less to do with confidence, bravado, and the “will to win” than some advantages you can observe and measure objectively. A post-modern price war is winnable first and foremost if the attacker can sustain it. Either the attacker has a significantly lower cost base than its competitors, or it has significantly higher financial power. This means it can operate for long periods on tight margins or even with losses. This provides yet another incentive for companies to remain private longer, shielded from the performance pressures of quarterly reporting and able to use profitable businesses to cross-subsidise fledgling ones. Second, the war needs to be containable. This has become much harder to do in an age of global trade and integrated supply chains, as we will discuss in the next section. We feel that most of the losses occur here, meaning that what looked like a sustainable war in one theatre becomes an unsustainable waste of resources if the theatre expands or switches.
The final component for winning a price war is an end game. Much like a chess match with a path to checkmate, the attacker needs to map out actions and reactions well in advance. Then they can decide when and under what conditions it can declare victory. In short, you can have an extreme cost advantage which can encourage you to launch a very disruptive business model. But you can still blow that opportunity if you overlook or discount the risks, or fail to have a careful path to checkmate.
Beyond these components is the storytelling element. Post-modern price war stories tend to follow the same arc built around the tantalising yet credible promise of growth. The attacker mounts a strong case that the market – or at least their niche – is on the verge of dramatic growth. They also claim that they will capitalise on this growth not only through scale in the core business, but the opportunity to tap secondary revenue streams. Finally, if network effects offer a competitive advantage and an eventual barrier to entry, they will redefine the market on those terms and explain how they will create those effects.
What does a company do when faced with this kind of attack? Clearly this is not the old “line up your soldiers” war of attrition. When these disruptive models emerge and the attacker’s success chances seem reasonable, the defensive strategy can’t be the direct price cut, a holdover from the “old school” price war. Companies faced with business model disruption need to respond with a much greater level of price sophistication and marketing techniques.
The challenge nowadays is to compete on price without cutting prices
Accept that the old model can’t win and find new ways to monetise your products and services. Alternatives could include low-cost alternatives, more complex price structures, bundling etc. and also fighting business model innovation with one’s own innovation.
The collateral price war: Contagious and quick to spread
In the “classic” price wars we have all read about in business books and economics textbooks, the price war begins with a competitor. In today’s globally interconnected world, the risk is greater than ever that a customer or a supplier will start your price war for you. Or at least provide the fuel and the igniter. Nowadays, a price war exports lower prices throughout the value chain, sweeping up companies who are unprepared for the shock and whose margins and business model may not be able to withstand it.
The supermarket price war which has raged in the UK for several years now has inflicted a considerable amount of collateral damage, as we will describe in more detail later. It has engulfed domestic and international suppliers, even the suppliers to these suppliers. They may have never thought their fates were linked to the sinking shelf prices at supermarket chains such as Tesco or Asda.
Customers can also suffer from price wars. The simplistic conclusion, part of the prevailing price war wisdom, is that customers love the lower prices which a price war creates. This benefit is neutralised when the lower prices come with lower quality, a likely outcome when a protracted war reduces profits. This in turn reduces investment in customer service and R&D. Price wars not only damage industries by making them less profitable, but also less attractive. In extreme cases, some markets are left with just one dominant player, reducing choice for customers. When profitable survival depends on lower quality, customers and investors will start to look for alternatives.
A company always needs to look left and right along the value chain. A price war can spread rapidly and intensely, even across borders. Customers who walked into an Asda supermarket in Stafford recently may be excused for thinking they were experiencing the latest in farm-to-fork sourcing techniques. Why else would there be cows in the supermarket aisles?
The cows were there as a protest by dairy farmers. They wanted to drive home the message directly to consumers that they cannot survive for long when milk costs less than bottled water. This is an example of the type of collateral damage that a price war can cause. The battle between the big four retailers, the discounters, and the emerging online rivals had started to claim victims along the supply chain. The damage has spread to other products and has even affected the suppliers to the suppliers.
These collateral price wars are especially scary. They happen quickly. They leave suppliers wedged between the volatility of their own input costs and the needs of the primary price war combatants (in this case, retailers) to lower their own costs by transferring the pressures and burdens to their suppliers.
Given our global world, these battles can become scourges. As conflicts spread along the value chain; you might not be involved in one directly at this time, but the ripple effects may reach you at any time as collateral damage. You should consider a price war either upstream or downstream from you in the value chain as a red-alert warning. The UK supermarket price war began at the bottom of the value chain and triggered massive, negative upstream effects which consumers generally don’t see.
The converse is also true. Upstream price wars can make downstream conditions worse. Take the recent crude oil price war between OPEC and non-OPEC members which can be seen as a negative cost shock impacting many industries to varying degrees. There are undoubtedly positive effects on stimulating demand and keeping inflation in check. But consider the disastrous deja vu implications for the oil sector, from job losses in West Texas in the 1980’s to recent cutbacks at the North Dakota oil fields. A crude oil price war – and this one is not the first – creates a domino effect on the value chain impacting the refining sector, oil and gas equipment manufacturers, service providers, governments’ current accounts, and even pension funds.
Upstream wars can also trigger price wars when someone downstream tries to capitalise on a newfound cost advantage which is not unique to them, but rather more or less similar across all their competitors. This happens, say, when lower crude oil prices result in lower prices for jet fuel and create the temptation for airlines to turn those lower costs into their own price advantage. The problem, again, is that lower kerosene prices are to everyone’s cost advantages. We feel that this is what prompted the warning from Ryanair chief executive Michael O’Leary, who said that “If there is a fare war in Europe, then Ryanair will be the winner.” In other words: you shoot, you lose.
Tackling these changes
All three of these changes are eye-opening and frightening in their own ways. The old view of price wars is obsolete. Gone is the narrow notion that a price war is little more than a cartoonish slugfest between a handful of entrenched and similar rivals, with the supposed “winner” able to claim a shallow victory at best.
Tackling these changes boils down to three things: vigilance, recognition, and creativity. Vigilance is important simply because of the pervasiveness of price wars, regardless of their form. Our biannual Global Pricing Studies reveal consistently that between 70 and 80 percent of all companies say there is a price war in their industry. Roughly half of all respondents see themselves involved in one. Price wars are more common in Asia, less common in North America and Europe, with a clear relationship between profit margins in a given country and the percentage of companies in a price war. Given the new ability of price wars to start quickly and unexpectedly, intensify, and spread globally, no executive can discount the risk of a price war or feel any sense of immunity.
What preventative, offensive, and defensive measures can you undertake? The answer starts with recognition of your situation and the motivations behind your competitors’ actions. The nuances of 21st century price wars have grown very diverse. Recognising your situation depends heavily on an accurate assessment of the motivation behind what your competitors, customers, and suppliers are doing, not the mere extent of any price move in isolation. Coming up with the strategy and tactics to fight a price war demands far more creativity than “how low should we go?” As we said before, the challenge nowadays is to compete on price without cutting prices. Alternative marketing strategies, clearer differentiation, and ultimately innovation, be it in products, services, or the business model, are essential approaches to minimising or even reversing the damage that a price war can cause.
The supermarket price war in the UK began as a traditional price war, yet the fact that it has morphed into something entirely different shows the power of the three changes which have forced us to rethink price wars. This price war features not only entrenched incumbents, but foreign disruptors such as Aldi and Lidl, and the online competitor Ocado. Ocado now faces new market entry of its own after Amazon decided to compete in the grocery market in London. At the same time it has inflicted considerable collateral damage on suppliers. Also on consumers, who may find some of their favourite products missing from store shelves and websites as the retailers and their major suppliers wrangle over rising input costs.
Long live the traditional price war? No
The textbook 20th century price war still happens frequently. One company among relative equals decides it wants to make a grab for market share, so it cuts prices significantly. In an attempt to stem share losses and restore equilibrium, competitors respond with price cuts of their own. The price war begins until desperation sets in as competitors see their margins, their share prices, and their reputations under threat. The US automotive market fell victim to this kind of war in 2005 when General Motors set a goal to gain market share of 29 percent. The move prompted price and product decisions which arguably set the company on its final descent into bankruptcy.
We expect that the balance of new to traditional price wars will alter significantly going forward. When traditional price wars start, they are liable to be “oops” price wars more often than planned aggression. It is harder to process the increase in market signals and clues in today’s compressed time frames. More and more markets also face the threat of the post-modern price wars as marginal costs for many products and services fall to zero. Plus, public and private financial markets value scale and volume more than they reward traditional financial metrics. Finally, price wars spread quickly because supply chains are so interconnected. As we said earlier, even the UK supermarket price war had all the markings of a “classic” price war before other forces took hold and reshaped it.
The unsophisticated use of lower prices as a response to these new business models is usually ineffective, especially over the long term. Too many people assume they can stop new entrants from entering markets with conventional means, when they can’t. This is where business process innovation comes into play, the ability to innovate rather than win on price. It is how Honda responded to aggressive market entry in one of its best markets for motorcycles. Honda held a 90 percent share of the motorcycle market in Vietnam until Chinese competitors entered the market. Their products were priced at between a quarter and a third of the price for Honda’s main model, the Dream. The penetration happened so quickly that the Chinese manufacturers soon sold over 1 million bikes per year, while Honda’s sales plummeted by over 80 percent to under 200,000 units.
Most companies would have chosen among three options at this point, all of them unattractive. Withdraw from the market, retreat to the small premium segment of the market, or cut prices drastically to win back some share. While Honda did briefly cut the price Dream by up to 40 percent, it ultimately chose “none of the above.”
Instead it undertook a radical reorientation and redesign which resulted in the Wave, an innovative product it described as having “low price, yet high quality and dependability”. Honda could manufacture and sell the Wave profitably because it produced it locally with a much simpler and much less expensive process and globally sourced parts. It priced the Wave roughly at parity to the Chinese motorbikes and reconquered the Vietnamese market so thoroughly that most of the Chinese manufacturers eventually withdrew. Honda demonstrated that you can win a price war decisively through innovation if you have the patience, resources, and commitment to lose battles in the short term.
So many misconceptions and myths have grown up around price wars over the last three decades. We are not surprised that executives and managers find price wars confusing, unsettling, hard to manage, and even harder to contain.
Attributing these challenges to the “fog of war” may sound dramatic. However, it conveniently sidesteps many solvable problems which can have destructive consequences for your company, no matter how noble your goals may sound or how strong your commitment may seem.
Rethinking price wars starts with understanding that no company is immune. The percentage of companies who think they are in a price war has hovered around roughly 50 percent for the last decade. Anything which directly affects half of all businesses around the world – in most cases negatively – is obviously worthy of the attention of C-level executives. What they should do is far less obvious.