A price war occurs when two or more rival companies lower the prices of their products or services with the goal of stealing customers from their competitors or gaining market share.
Price wars come at a significant, albeit temporary, cost since they decrease a company's profit margins in the short term. If the company gains a sizable increase in market share, it can lead to more profitability in the long term, particularly if the competition is no longer a viable threat.
There are a number of pros and cons for the companies involved in price wars, as well as for the consumers being courted. Read on to find out more.
Key Takeaways
- Price wars can come at a high cost in the short term since they decrease a company's profit margins.
- However, price wars can help the victor gain a sizable increase in market share, leading to greater profitability in the long term.
- Price war strategies can include lowering prices for certain products and then cross-selling consumers higher-margin services.
How Price Wars Work
A Company Lowers Its Prices
Lowering prices is one of the most common strategies that companies use to increase market share for a product. If their competitors also lower their prices, a price war begins.
Price wars are most common in industries where there is both heavy competition and comparable products. Under these conditions, there is an incentive for a competitor to cut prices in order to gain a greater share of the market.
Competitors Slash Their Prices
The competing companies are often forced to follow suit and lower their own prices. As a result, the number of sales for the products increases but each product is sold for a lower price, leading to lower profits in the short term.
At some point, one of the competing companies reaches its breaking point, meaning it can't afford to lower its prices more. It risks losing profits and potentially harming its long-term viability. Companies with fewer financial resources may even be driven out of business.
Lower prices on certain products are often accompanied by offers of extra products and/or services, or incentives to switch brands.For example, some marketing strategies might include offering a free subscription-based service for one year, added services with a product purchase, or a buy-one-get-one-free (BOGO) offering.
Whatever strategy is employed, the idea behind a price war is to gain market share and hurt the competition.
Cutting prices is not the only way to fight a price war. Companies can also respond to their competitors by augmenting their products with added services or buy-one-get-one (BOGO) offerings.
Advantages of Price Wars
For consumers, lower prices mean savings. They may also get additional products and services offered as part of the deal.
For big-ticket items, the benefits can be substantial. If car companies are engaged in a price war, consumers might be able to score a higher-end model that otherwise would have been too expensive. They might also be able to get better financing or better service terms, such as a longer warranty—all thanks to the price war.
Companies and workers can benefit from price wars since the winning company can become more financially profitable and ensure its longevity, which can lead to more jobs for the economy.
Disadvantages of Price Wars
There can be serious consequences from price wars. If a large firm drives competitors out of business through aggressive price-cutting, consumers are left with fewer choices in the end.
The remaining company gains pricing power over time since there are no competitors. A company that has gained a sizable market share can raise prices at will.
Meanwhile, workers are left with fewer companies that need their skills. The damage from price wars can be especially harsh in regions that have only a few large employers.
With less competition, workers are forced to either accept lower-paying jobs or move to find a different job.
Pros and Cons of Price Wars
Pros
Consumers save money
Consumers may get additional products or services
Companies gain new customers
Cons
Companies lose market share and profits
Less competition can mean less consumer choice and higher prices
Workers can be left with fewer employment choices
How Firms Can Respond
An article published by American Express argues that the best response to a price war is to sidestep direct conflict through a variety of strategies.
One possible tactic is to differentiate the firm's product offering from that of the lower-cost competitor. If a firm can offer a product that is unique or superior, or augment its value with future discounts and bundled freebies, it will be in a better position to preserve its pricing power.
Examples of Price Wars
Although price wars have typically consisted of companies offering commodities, it has recently expanded to include companies offering a wide array of services.
The marketing strategy includes lowering the prices of products but charging for related services down the road.
Brokerage Price War
Brokerage firms were engaged in a price war throughout 2018 and 2019 in an attempt to gain customers.
Exchange-traded funds (ETFs) had become extremely popular investment products for investors, not least because of their very low fees. (ETFs contain stocks or other investments that track an index, such as the S&P 500.)
Investors typically paid commissions for buying and selling ETFs, just as they did for stocks. Charles Schwab was one of the first brokers to offer zero transaction fees for ETFs.
Fidelity Investments quickly fired back, striking its own deal with iShares to offer a choice of several no-transaction-fee ETFs for its customers. Vanguard also moved to offer its ETFs with no trading fees.
By the time the price war came to an end, all of the major online brokerages were offering free transactions for stock trades as well as ETFs.
For brokers like Schwab, the goal of a price war war was to gain new clients and their deposits, and allow the firm to cross-sell its banking products and wealth management advisory services.
2020 Oil Price War
Another example is the 2020 price war between Russia and Saudi Arabia, which ultimately led to a 65% drop in oil prices.
The price cuts were caused by a breakdown in negotiations between Russia and OPEC for a worldwide agreement to cut production. When negotiations failed, Saudi Arabia announced cuts to oil prices, causing the prices of Brent blend and West Texas Intermediate to fall dramatically in the following days. Russia and the United Arab Emirates both followed suit by increasing production.
The price war, combined with falling demand caused by the COVID-19 pandemic, briefly resulted in oil prices falling below zero in certain markets.
How Can a Company Avoid a Price War?
If a company thinks it has the better product, it should communicate that to the consumer through rebranding, marketing, and promotion rather than with lower prices. It might also consider adding a bonus to its product to give consumers a reason to choose it over the competition. In the best-case scenario, waiting out a price war damages the aggressor while leaving the competitor better off in the long run.
Is a Price War Good for Consumers?
Most price wars are short-term and they might give consumers a chance to stock up on a favorite product at a bargain price. Sometimes the buyer scores a really substantial benefit. For example, an auto manufacturer might offer lower-cost financing in addition to (or instead of) engaging in a price war with a competitor.
Is a Price War Good for Business?
It may be if a company winds up with a greater market share than it had when the war started. However, it could be a game-ender for the competitor on the losing end. A price war also can lower prices in the long run. Online brokerages appear to be stuck with zero-cost trading for at least some of their financial products. No one wants to be the first to test what happens when that offer is withdrawn.
The Bottom Line
A price war is an event that occurs between companies when one company lowers prices to gain customers and other companies join in.
The advantages of price wars can be savings for consumers and greater profitability and growth for companies. The disadvantages can be fewer product or service choices for consumers, plus higher prices. For employees, price wars can mean a loss of jobs.
