How to fight a Price War?

Your actions impact your competitors, and their actions impact you. So the second pricing principle is to ensure you don't start a war ...

Your actions impact your competitors, and their actions impact you. So the second pricing principle is to ensure you don't start a war you can't win.

What if you sell your item on average for $20, and an impressive new competitor starts regularly selling a very similar item for $10?

While that new low price may be good for customers, it's bad for you. If either you or your competitor decides to employ penetration pricing, even if it's just through a short-term sale, then the other person has to decide what they're going to do in response.

How to fight a Price War

Do you match the offer? Do you ignore it? Do you offer an even deeper discount?

Don't Start A Price War You Can't Win

Most pricing managers, in the absence of a real pricing strategy, arbitrarily put items on sale when they feel like sales are slow, and hope that prospective customers notice and decide to buy. Or maybe they have too much of a certain item, so they decide to put it on sale to get sales moving.

These managers also hope that prior purchasers who paid a higher price, the competition, and their bookkeeper don't notice these sales events, because these people will be upset about the new low price.

In my view, putting items on sale arbitrarily says three things:
  • First, it's saying to your competitors that you want to pick a fight.
  • Second, it's signaling to your shoppers that your prices are too high.
  • Third, it's telling everyone that your sales are too low, your inventory is too high, and you're desperate.
None of these are good messages to send to your prospects or current customers.

Before you put things on sale, or offer discounts, think long and hard. Consider the profit margin you're sacrificing and whether you can truly afford it. Consider how your customers will perceive you and your products after the sale is over. Consider what your competitors might do in response.

Part of the problem with short-term promotional sales is that both the customers and you get addicted to them. Customers change their behavior when short-term sales are added into the equation. When you do a sale customers learn quickly that if they wait, the item will go on sale again, therefore they delay buying.

Managers get addicted to short-term discounts and sales because they boost short-term results. The more pressure there is to hit short-term sales goals, the more there is a temptation to hold a sale or offer a discount. But over time, just like an addiction to any bad behavior, the negative consequences will catch up to you. You will go out of business.

Starting The Price War You Can't Win

Since most of the people reading this won't follow this advice, and will eventually find a reason to start a price war, then let me give some thoughts on doing it.

If you enter a serious price war by committing yourself to penetration pricing over the long-term and you take lots of customers away from your competitors with this strategy then you're left with lots of new customers that permanently expect the lower prices.

If you can actually make a profit selling at the new lower price, then you survived the price war. But don't expect to re-inflate your prices very easily - that's like trying to rehydrate beef jerky life doesn't work that way.

Of course, you'll also have to brace yourself for a troubling fact. There is almost always someone who can make a product, or deliver a service, cheaper than you can. You've got to prepare for them doing the same thing you just did and this time you've got to figure out how to survive it.

The only price war that makes any sense is the price war that you win and by winning it you become the market leader. The leadership position in a market is worth battling over. But you shouldn't try to start that battle unless you have a serious shot at winning.

How Costco Wins The Low Price War

You might be saying to yourself, “Well, obviously the low price leaders do well, why not be one?”

The reason it is difficult to be one is because you have to create a way to sustain your low prices. A great example is Costco, the Seattle based warehouse store. If you look at their total revenue, they are the 4th largest retailer in the U.S. behind Wal-Mart, Kroger, and Target.

But Costco only has 435 stores, whereas the others have between 1,778 and 4,550. So Costco makes more money from each store than anyone else.

How do they sustain their business so successfully? They use several strategies, including:
  • They charge everyone who enters the store an annual membership fee. This helps provide additional revenue.
  • They only sell bulk items. So a funny thing happens: Customers pay more for a bottle of Aspirin at Costco than they do at Walgreens. The difference? They are buying 4 times as much. So the price is higher and the quantity is higher.
  • They don't do any advertising or promotions. They depend on word of mouth and the loyalty of their members.
I didn't understand the full business value of these strategies until I heard the founder, Jim Sinegal, speak at a business dinner. There was an open Q&A time with him, and someone asked, "Why don't you sell things in smaller quantities, like a 100 count bottle of Aspirin, instead of just the 500 count bottles?"

Jim's answer was simple.

"Because people would buy them"

That night I realized what he was doing. He's providing a discount to customers in exchange for them making a bigger purchase than they otherwise would have wanted to make.

Those bigger purchases allow Jim to get bigger discounts from manufacturers when he is negotiating the prices from his suppliers.

So while you can go to Walgreens and buy aspirin for $6.99, you're only getting 100 pills. When you go to Costco and buy aspirin you're spending $13.99, twice as much. But you're getting 500 pills. You're getting five-times as much on a per pill basis.

This allows Costco to transact fewer orders as well, for higher total dollar amounts. So while they are a low-price leader, their business model allows them to reap many of the rewards of being a premium provider.

These strategies and others allow Costco to maintain its system of low-cost selling. Like Costco, if you're going to embark on that venture, ensure you have systems in place that make your low-cost selling strategy profitable.

Forced Into Price Wars You Don't Want

If you've tried to sell items for a fixed price on Etsy or eBay then you understand the problems related to open marketplaces that don't have any pricing controls.

You're almost forced to compete on price.

This wild-west type environment creates a "race to the bottom" where people compete on price, by constantly lowering prices; until there is no possible way anyone can make money. You want to avoid these situations at all costs.

How to fight a Price War Action Step

If you're addicted to promotional sales and discounts, work to stop them. If you use them occasionally, work hard to find new alternatives like promotions, contests, and fun engaging social activities. If you've considered using penetration pricing as a strategy to gain market share, be sure you know what you're doing.

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