People are competitive. Companies are competitive. They want to beat each other, they want to “win.” That’s why otherwise smart people often start or join price wars. Price wars transfer money from sellers to buyers. This is not a good thing if you’re a pricing person, or the CFO.
AMD and Intel are in a price war at the moment, which has punished shareholders of both companies. Intel, with greater manufacturing capacity and a stronger cash position, thinks it can “win” this war of attrition. While they will fair better than AMD, their quarterly profit was down 39%.
Companies start price wars to “win market share.” Sometimes, this is based on a careful analysis of lifetime customer value to support aggressive pricing to certain market segments. More often, it’s just a matter of competitive instinct coming ahead of profit.
Either a price cut will cause a shift in market share or it won’t. If it doesn’t, you’ve just given your customers a big discount and hurt your bottom line. If it does, your competitor is likely to respond, negating your advantage. Market share remains essentially unchanged, but prices and profit are lower. This often leads to more desperate attempts to lower prices to win business.
Does this mean that lowering prices is always a bad idea? Of course not. Aggressive pricing and all-out price wars can be very effective if you know what you’re getting into. The key question is: do you have a sustainable cost advantage? Southwest has a lower cost per passenger seat mile than its “major” competitors, so it can price below them. The majors cannot profitably follow Southwest into this territory, but they do. Then they cut corners on the very service elements that used to differentiate them from Southwest. However, they have intrinsically higher costs, so they can never truly match the low fare carriers. Wal-Mart can start a price war with KMart, but KMart had no business joining in. They should have differentiated in other areas, as Target has done quite successfully.
Many companies get into price wars without even understanding the comparative cost position. In some cases companies overreact to perceived price threats, lowering prices across the board when competitors have in fact offered only narrow discounts. These moves can reduce the profitability of an entire industry for years, so tread carefully.
Most companies reward people for their contributions to the bottom line, not for hurting their competitors’ bottom lines. Ultimately, shareholders pay the price (bad pun), so they should hold companies accountable for irresponsible price wars.