Price Wars: The Cost Of A Competitive Behaviour

PRICE WARS: THE COST OF A COMPETITIVE BEHAVIOUR

Introduction

Price wars have racked industry after industry in recent years: from personal computers to mobile phones, from fast-food restaurants to airlines, from grocery retailing to computer software, from beers to frozen diet dinners, from automobile tires to disposable diapers, from detergents to underwear. All too often, there are no winners - and few healthy survivors. Price wars indeed represent one of the extreme forms of competitive interplay in the market place, causing great losses. On the one hand, firms take a blow in terms of ability to innovate, consumer equity, and margins; they may forego their competitive advantage, fall victim to substitutes, and even face bankruptcy. On the other hand, consumers, benefit from lower prices in the short run. In the long run, however, they may develop unrealistic reference prices and suffer from lower quality products in the long term. In a broader contest, society may suffer from suboptimal allocation of resources.

Definitions

Basically, price wars represent competitive behaviour. Price wars are marked by competing firms struggling to undercut each other (Assael, 1990) and may occur if one company lowers its price and competitors match the price (Urban and Star, 1991). It is proposed that such wars can be viewed as "engagement involving two or more vendors seeking to achieve a goal that each is determined to attain and in which the rival vendors...make successive moves and countermoves in an attempt to gain an advantage or to resist any advantage gained by the other" (Cassady, 1963, p. 2). Other researchers (e.g., Urbany and Dickson, 1991) suggest that price wars commonly start with one firm trying to take hold of market share. The result of such a price is downward price pressure that eventually drives other competitors to follow the initial move.

Moreover, price wars typify wars of attrition. According to Besanko et al. (1996), "In a war of attrition, two or more parties expend resources battling with each other" (p. 426). Likewise, it is maintained that such warfare is a period in which the firms set prices that are significantly below the prices commonly charged in the industry (Busse, 2000). According to Slade (1989) price wars entail that one competitor cuts price to punish another competitor for violating a rule of competitive conduct. Consequently, the firm to be punished reacts through another price cut, prompting further such cuts by the competitor, and so on. Thomas and Soldow (1988) state that if a price cut violates industry rules, competitive turmoil may result.

Price War as a Competitive Behaviour

As stated in the previous section, price wars are a competitive behaviour. Marketing researchers have provided a number of directional insights into the price war phenomenon. For example, in an empirical work by Putsis and Dhar (1998), it is shown that competitive interaction varies significantly across categories depending on the demand and competitive characteristics of the category. In a later study by Heil and Helsen (2001), early warning signals of price wars are used to explain this competitive behaviour. The authors identify four general factors that influence price wars: (1) market conditions, (2) firm characteristics, (3) product-related factors, and (4) consumer factors.

In terms of market conditions, Heil and Helsen (2001) hypothesise that: as market entry occurs and an entrant gains or is expected to gain a sizable market position, a price war becomes more likely; if an industry possesses excess capacity, the emergence of price wars is more likely; price wars are more likely to occur and to be more intense in markets with marginal growth; and the incidence of such war is relatively high in markets where market power is highly concentrated and fragmented markets and low for markets with intermediate levels of concentration. In terms of firm characteristics, the authors propose that: as exit barriers increase, the likelihood of price wars grows as well; price wars are less likely to emerge in markets where a single firm is viewed as being the price leader; they are less likely to emerge in markets where firms have established a strong reputation for toughness by combating past deviations; as financial conditions of at least one firm in an industry worsen, price wars are more likely to erupt; and as a firm approaches bankruptcy, the likelihood of price wars in an industry increases.

Moreover, Heil and Helsen (2001) suggest that: the higher a product's strategic importance to a company, the higher the likelihood of a price war; the more commodity-like the products in a market, the more likely a price war; the more "premium" a product, the lower the likelihood that a price war erupts; and the introduction of head-to-head products increases the likelihood of a price war. Lastly, the authors propose that the lower the brand loyalty in a market, the more likely an outbreak of a price war; and the higher consumers' price sensitivity, the higher the likelihood and intensity of price warfares.

Threats of Price Wars

In the early 1990s, price wars in the British automobile industry were intense. In July 1991, the British subsidiary of Ford Motor Co. announced price cuts of Ј1,000 for its Fiesta, Escort, Orion, and Sierra models, while luxury models such as Granada and Scorpio would come down by Ј2,000. Other incentives include free insurance and no-interest credit. Other auto manufacturers were under pressure to follow suit: Nissan UK soon announced price cuts and Vauxhall, the British subsidiary of General Motors Corp., announced that it would review its own prices. This move was met with alarm. "This is a price war," said Karl Ludvigsen, head of the London-based car-industry consultancy Ludvigsen & Associates. He added, "The question is whether Ford's move will bring order to the market by formalizing what's already going on at the dealership, or start something destructive" (Bruce, July 4, 1991).

In May 2002, two British tabloid papers, the Daily Mirror and the Sun, were engaged in an enraged price battle, with each slashing their cover prices by a third. The warfare started when the Daily Mirror, whose daily circulation is 2.5 million and trailing behind its longtime rival, The Sun, announced it would cut its price from 32 pence to 20 pence starting May 20. According to Mirror editor Piers Morgan, the move was part of a long-planned strategy to increase readership. "We believe we have a terrific paper and are using its price to ensure it reaches a wider audience," he said. Declaring