Price Wars: Today's New Reality of Price Optimization: Part 1

Price optimization is the key to your success in the battle with price wars

Do price wars have to happen?

In highly competitive industries, price wars invariably occur from time-to-time. If you have not experienced a price war lately, consider yourself lucky! At best, a price war is just around the corner again. With the drumbeat of competition constantly pounding, what should you do? Expanding market share is often the penultimate goal of many growing companies, but sadly, its often coupled with a grave toll on profit margins. The thinking goes something like this:

“If we pencil in a growth curve of “xxx” percent, then the additional volume should make up for the loss in profits. And boy, will it hurt company xyz, whom we compete with and want to overtake”.

That is both the justification and the rationale when a company starts a price war, and in time, profits do plummet. Could they drag the entire industry down with it? It all depends upon how you and other players react. Take heart, because in most cases, price cuts only work for a while. You have more influence and power than you might realize if you are on the receiving end of an aggressive competitor move. In retail and distribution, processing greater unit volume does not always equal greater profits. In some cases, more units may afford a cheaper rate of expense from a supplier, but (especially in retail) the expense to process additional units of product weigh heavily on narrower margins. The equation can be dangerous!

Why do companies feel that they must compete on price alone? There are many reasons for this mindset, and it cuts across all business types: Smaller competitors, new entrants to the market, and bold merchandisers with deep pockets. They often feel that in order to expand their market share, price is the most effective lever they can pull - at the expense of margin. So, it follows that unless there is some particular known edge that your competitor has, they will at some point return to sanity. It often occurs after a few months of battered balance sheets. So, the million-dollar question is, if they are willing to cut the price, should you respond, and if so, how should you respond? Hint: (you should respond). But how?

First, Diagnose:

Pricing battles can escalate quickly. You need to stop before reacting, take a deep breath, and understand both the causes and consequences, and what your participation effort should look like. The first step is you must diagnose. When a competitor makes an aggressive price move, unmistakably, they have started a price war. Often, a price war begins because one party suddenly obtains new valuable information-insight that was previously unknown to them, or has found suppliers that lowered their cost. This suggests a cost+ pricing mentality in your competitor, which in turn suggests that they have not fully grasped, or are ignoring the importance of value-based pricing.

Usually it is no more complicated than an enterprise wanting to capture more market share. This competitor’s strategy could be a part of a larger, more complex strategy over a longer period. They might be thinking lower pricing now, value pricing later. Later when? It depends in no small part upon your reaction to their move. In any event, a competitor willing to dump prices needs evaluation. Your goal is to end the price war quickly if possible, and in turn preserve your own profitability.

A side note:

It is important to understand that just as companies lead others into a price war, conversely – companies can also lead others into raising their prices on certain products and lines. Don’t believe it? Remember, they are watching your moves too. If you practice value based pricing, they will begin to wonder why is it - some of your prices have moved up, and some product prices down? If they are savvy, they might suspect price optimization systems are at work. If they know that you have price optimization, it is highly likely that they’ll start following your moves. This would be great news, as the entire industry becomes more profitable, and you can then compete on other things besides price!

The trap of believing that they know what your reaction will be:

This also suggests that your competitor has made assumptions about your reactions to their moves. They likely have inaccurate or incomplete information on how you might react. In fact, in their smug anticipation of higher volume, initially, they may not be concerned with your reaction. They may assume that you cannot react fast enough. If you have the right technology, they would be dead wrong. You may be able to surgically optimize your price discounts to meet their most visible moves in prompt reaction to their action, both preserving your profits and answering their moves at the same time.

Publicize your intentions:

At any rate, you must attempt to avoid a downward price spiral, so it is important that you quickly signal your pricing intentions in public. How do you do that? Before we get to the how, understand that by doing so, you are making clear your intentions so that the competitor understands that their moves will unlikely achieve the desired result, and are certain to be met with resistance.

The solution is, to stop the war before it begins:

You must in-fact reveal your strategic intentions to your competitors ahead of time. Price matching and other public statements (In your policies, marketing and advertising) will signal to your competitors that you will not tolerate a price war, and intend to fight using all resources at your disposal. Make sure that your competitors understand the rationale behind your pricing policies. This should go a long way to preventing a price war.

As always, I hope that this information has been helpful to you, and best of luck in your pricing journey.

© 2012 COPYRIGHT ADVANCED PRICING LOGIC SOFTWARE, INC. No part of this document may be reproduced without permission from APLI. All rights reserved. *Legal Notice: Statements made herein shall not be construed as precise representations or warranties of performance. Performance and other claims made herein will vary depending upon the enterprise business model using Promoter®. Statements concerning the use, benefits and performance of Promoter® price automation and optimization are based upon case studies, both in alpha, beta testing and in actual practice. Factors that could cause actual results to differ materially may include general business and economic conditions, competition, unique business practices and other risk factors.