Price war

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A price war is a form of market competition in which companies within an industry engage in aggressive pricing activity "characterized by the repeated cutting of prices below those of competitors". [1] This leads to a cycle, where each competitor attempts to match or undercut the price of the other. [2] Competitors are driven to follow the initial price-cut due to the downward pricing pressure, referred to as “price-cutting momentum”. [3]

Contents

While price wars can offer short-term benefits to consumers by providing them with lower prices, they can have a negative impact on the companies involved by reducing their profit margins. Moreover, the negative effects of price wars on companies can extend beyond the short term, as the companies involved may struggle to recover their lost profits and maintain their market share. [4] Firms may be cautious when engaging in price wars as this competition can lead to prices that are unsustainable for long-term profitability. [5]

Definition

The repeated cutting of prices is highlighted in the Merriam-Webster Dictionary definition of a price war. [1]

Heil and Helsen (2001) proposed that a price war exists only if one or more of a set of qualitative conditions are satisfied. These conditions include:

  1. a primary focus on competitors rather than consumers
  2. undesirability of pricing interactions for competitors
  3. absence of intention to start a price war by any competitor
  4. violation of industry norms through competitive interactions
  5. accelerated pricing interactions in comparison to the usual pace
  6. a downward direction of pricing
  7. unsustainable pricing interplay. [4]

Causes

The main reasons that price wars occur are:

  • Applying game theory, two oligopolistic firms that engage in a price war will often find themselves in a kind of prisoner’s dilemma. Indeed, if Firm A reduces its prices whilst competitor, Firm B, doesn’t reduce its prices, then Firm A can capture market share. And, if Firm A reduces its prices, then Firm B must reduce its prices to avoid being eliminated from the market. The equilibrium is such that both firms adopt a low-price strategy to protect themselves. [6]

Reactions to price challenges

The first reaction to a price reduction should always be to consider the following:

Has the competitor decided upon a long-term price reduction or is this just a short-term promotion?

If the competitor has implemented a short-term promotion, the ideal response is to monitor the competitor's price changes and maintain prices at the current level. Price wars often begin when simple promotional activities are misunderstood as major strategic changes. [2]

If the competitor is implementing a long-term price change, the following reactions may be suitable:[ citation needed ]

Effects

Empirical studies suggest that price wars can significantly damage the companies that practice such behaviour. [4] Notably, price wars can have some short term benefits for firms as it allows them to quickly turnover inventory, alleviate financial pressure, increase social purchasing power, and may compel firms to enhance their production efficiency. [6] But these short term gains are ultimately offset by long term losses. In the long run, price wars can cause companies to incur losses in their margins, customer equity, innovation capabilities and competitive advantage. Victims of price wars may be downgraded in the market, and even incur bankruptcy. [11] [12] But the companies that involve themselves in price wars are not the only affected parties, as suppliers and investors will also be impacted. This can lead to compromised company image and reputation over the long run. [4] Overall, society may suffer from less efficient allocation of resources as the resources that were poured into participating in a price war could have been allocated elsewhere. In the short term, consumers appear to benefit from lower prices during a price war. However, in the long run, consumers are likely to form unrealistic reference prices and may be faced with lower quality products. [13] [2]

The international organization ActionAid published a report in 2007 entitled Who pays?, which analysed the impact of supermarket price wars on the income and lives of women in the developing world. The report quoted the words of a banana supplier in Costa Rica:

We are paying for the price wars between supermarkets in your country [UK]. [14]

The report was listed for debate under an early day motion in the UK's House of Commons in 2007. [15]

Examples

Price wars are prevalent in many industries, [2] with academic literature citing cases in market segments, including: electricity, [16] telecommunications, [17] automotive, [18] and airlines. [12]

Price wars have been documented in airline markets around the world. Emirates Airbus A380-861 A6-EER MUC 2015 01.jpg
Price wars have been documented in airline markets around the world.

Some key examples include:

See also

References

  1. 1 2 "Definition of "Price war"". Merriam-Webster. Retrieved 23 April 2023.
  2. 1 2 3 4 5 Rao, A.R; Bergen, M.E.; Davis, S. (2000). "How to fight a price war". Harvard Business Review. 78: 107–116.
  3. Urbany, J.E.; Dickson, P.R. (1991). "Competitive Price-Cutting Momentum and Pricing Reactions". Marketing Letters. 2 (4): 393–402. doi:10.1007/BF00664225. S2CID   73560463.
  4. 1 2 3 4 Heil, O.P.; Helsen, K. (2001). "Toward an Understanding of Price Wars: Their Nature and How They Erupt" . International Journal of Research in Marketing. 18 (1–2): 83-98. doi:10.1016/S0167-8116(01)00033-7.
  5. Slade, M.E. (1992). "Vancouver's gasoline price wars: An empirical exercise in uncovering supergame strategies". Review of Economic Studies. 59 (2): 257–276. doi:10.2307/2297954. JSTOR   2297954.
  6. 1 2 3 Yi, L. (2021). "E-commerce Price War Based on Game Theory". Proceedings of the 2021 3rd International Conference on Economic Management and Cultural Industry (ICEMCI 2021). Vol. 203. Atlantis Press International B.V. doi:10.2991/assehr.k.211209.533. ISBN   978-94-6239-483-4. S2CID   245787126 . Retrieved 23 April 2023.
  7. Dean, J. (1976). "Pricing Policies for New Products". Harvard Business Review. 54 (6): 141–153.
  8. "Oligopolistic Competition". Monash Business School. Monash University. Retrieved 23 April 2023.
  9. ACCC (26 March 2023). "Misuse of market power". Commonwealth of Australia. Retrieved 23 April 2023.
  10. European Parliament (27 June 2018). "Dumping explained: definition and effects". European Parliament. Retrieved 23 April 2023.
  11. Bhattacharya, R., 1996. Bankruptcy and Price Wars. Working Paper, University of Melbourne.
  12. 1 2 Busse, M.R. (2002). "Firm Financial Conditions and Airline Price Wars". RAND Journal of Economics. 33 (2): 298–318. JSTOR   3087435.
  13. Blattberg, R.C., Briesch, R., Fox, E.J., 1995. How promotions work. Marketing Science 14, G122–G132.
  14. ActionAid (2007), "Who Pays? How British Supermarkets are Keeping Women Workers in Poverty", page 2
  15. UK Parliament, ActionAid Who Pays? Campaign, tabled on 18 May 2007, accessed on 5 March 2025
  16. Fabra, Natalia and Juan Toro (2005). "Price Wars and Collusion in the Spanish Electricity Market". International Journal of Industrial Organization. 23 (3–4): 155–81. doi:10.1016/j.ijindorg.2005.01.004. hdl: 10016/5004 .
  17. Young, S. (2004). "MCI Offer Shows Price War Persists In Long Distance". The Wall Street Journal. Retrieved 23 April 2023.
  18. Breshnahan, T.F. (1987). "Competition and Collusion in American Automobile Industry: The 1955 Price War". Journal of Industrial Economics. 35 (4): 457–82. doi:10.2307/2098583. JSTOR   2098583.
  19. 1 2 Jacobs, T. (2020). "OPEC+ Moves To End Price War With 9.7 Million B/D Cut". Journal of Petroleum Technology. Society of Petroleum Engineers. Retrieved 24 April 2023.
  20. "Oil rents (% of GDP)". The World Bank. World Bank Group. Retrieved 24 April 2023.