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Price Competition Reaction
A price war is a negative sum game and managers need to be fully aware of the costs it imposes on all the participants in the game. It is imperative that managers think coolly before initiating price competition. But the question still remains of how a company should respond, should a competitor initiate price competition. In this section we will discuss in step-by-step detail how to analyze a competitive situation and react to price competition that is not of your making.
Step 1
The first action is to ask is that “Is there is a response that would cost less than the preventable sales loss?” is the cost of responding less than the sales loss which can be prevented? Mangers need to conduct a financial analysis of a reactive price change and if it is concluded that reacting to the price change is cheaper than losing sales then it may be a good business decision to respond. But further thinking is required before one comes to that conclusion.
Step 2
The next question to ask is “how much sales loss is really preventable”? whenever a newer competitor enters the market, some sales loss is inevitable, even if the company matches the price cut, because people may shift for reasons other than price.
Step 3
If one were to reach the conclusion that a substantial portion of sales loss is preventable, then the next question to ask is “If you respond, is your competitor willing and able to cut price again to match your price levels?” Asking this question forces managers to think two or three moves ahead. If the competitor matches your price reaction, then any advantage the company might have gained is nullified. At this stage, companies cannot backtrack on their price reaction and find themselves in an irretrievable and unviable situation.
Step 4
Going back to step three, if the competitor is able to match your price reaction, then the next question to ask is “will the multiple actions and reactions required to match a competitor still cost less than the avoidable sales loss?” this forces managers to think about the total cost of the price war rather than cost of singular pricing actions. Multiple responses take prices into a downward spiral, at the end of which either the competitor may still hold the advantage or neither company nor competitor may hold the advantage. In any of these two scenarios, the company is still the loser and will find itself in an irreversible situation.
Step 5
So far we have looked at all responses where the cost of responding was less than the sales loss. We now need to look at situations where the cost of responding is more than the sales loss i.e it is cheaper to accept the sales loss than to respond to the price cut. The logical answer to this question would be for the company to accommodate or ignore the price cut and focus its efforts in other areas we stated earlier. But the answer is not so straight forward. Competitors pricing actions may end up threatening the company’s business in other territories and market segments or the customer segment in which the price cut has been initiated is strategically important to the company.
Step 6
The question now asks is if “the company’s position in other markets is threatened if the competitor gains share?” This could happen in cases where companies sell a range of complementary products; hence loss of share in one product category may affect sales of the related categories. If the response is ‘yes’- the market position is threatened, mangers need to further evaluate the value of the markets at risk to justify the high cost of responding before they actually decide to retaliate.
Competitor is strategically weaker/cost of responding is too high
We have seen earlier that when the cost of responding is too high, it may advisable to ignore the price cut. This is an appropriate response when the competitor is strategically weaker with no competitive product or cost advantages and when the sales one stands to lose may be small and limited.
But one could argue this differently to say that if the competitor is indeed weaker, why should the competitors pricing action be ignored, even if it is costly. A company which is stronger should use its competitive strength and resources to drive out a weaker competitor. Finding a flaw in this logic is difficult but the consequences of this action must be understood first. Firstly it is dead end path, as a weak competitor is likely to get driven out of the market due to the market forces anyway. Whether a company should actually compromise its profits in driving out a “weak” competitor is the question. Secondly it would be a misconception to think that by driving out weak competitors, one can actually eliminate competition.
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Step 1
The first action is to ask is that “Is there is a response that would cost less than the preventable sales loss?” is the cost of responding less than the sales loss which can be prevented? Mangers need to conduct a financial analysis of a reactive price change and if it is concluded that reacting to the price change is cheaper than losing sales then it may be a good business decision to respond. But further thinking is required before one comes to that conclusion.
Step 2
The next question to ask is “how much sales loss is really preventable”? whenever a newer competitor enters the market, some sales loss is inevitable, even if the company matches the price cut, because people may shift for reasons other than price.
Step 3
If one were to reach the conclusion that a substantial portion of sales loss is preventable, then the next question to ask is “If you respond, is your competitor willing and able to cut price again to match your price levels?” Asking this question forces managers to think two or three moves ahead. If the competitor matches your price reaction, then any advantage the company might have gained is nullified. At this stage, companies cannot backtrack on their price reaction and find themselves in an irretrievable and unviable situation.
Step 4
Going back to step three, if the competitor is able to match your price reaction, then the next question to ask is “will the multiple actions and reactions required to match a competitor still cost less than the avoidable sales loss?” this forces managers to think about the total cost of the price war rather than cost of singular pricing actions. Multiple responses take prices into a downward spiral, at the end of which either the competitor may still hold the advantage or neither company nor competitor may hold the advantage. In any of these two scenarios, the company is still the loser and will find itself in an irreversible situation.
Step 5
So far we have looked at all responses where the cost of responding was less than the sales loss. We now need to look at situations where the cost of responding is more than the sales loss i.e it is cheaper to accept the sales loss than to respond to the price cut. The logical answer to this question would be for the company to accommodate or ignore the price cut and focus its efforts in other areas we stated earlier. But the answer is not so straight forward. Competitors pricing actions may end up threatening the company’s business in other territories and market segments or the customer segment in which the price cut has been initiated is strategically important to the company.
Step 6
The question now asks is if “the company’s position in other markets is threatened if the competitor gains share?” This could happen in cases where companies sell a range of complementary products; hence loss of share in one product category may affect sales of the related categories. If the response is ‘yes’- the market position is threatened, mangers need to further evaluate the value of the markets at risk to justify the high cost of responding before they actually decide to retaliate.
Competitor is strategically weaker/cost of responding is too high
We have seen earlier that when the cost of responding is too high, it may advisable to ignore the price cut. This is an appropriate response when the competitor is strategically weaker with no competitive product or cost advantages and when the sales one stands to lose may be small and limited.
But one could argue this differently to say that if the competitor is indeed weaker, why should the competitors pricing action be ignored, even if it is costly. A company which is stronger should use its competitive strength and resources to drive out a weaker competitor. Finding a flaw in this logic is difficult but the consequences of this action must be understood first. Firstly it is dead end path, as a weak competitor is likely to get driven out of the market due to the market forces anyway. Whether a company should actually compromise its profits in driving out a “weak” competitor is the question. Secondly it would be a misconception to think that by driving out weak competitors, one can actually eliminate competition.
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