A price war is when two or more rival companies lower prices of comparable products or services with the goal of stealing customers from their competitors—or gaining market share. Price wars can come at a great cost since it decreases a company's profit margins in the short term. However, if a 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.
- A price war is when two or more rival companies lower prices of comparable products or services with the goal of gaining market share.
- Price wars can come at a high cost since it decreases a company's profit margins in the short term.
- However, price wars can help the victors gain a sizable increase in market share and lead to more profitability in the long term.
- Price war strategies can include companies lowering prices for products to add customers and cross-sell them higher-margin services.
How Price Wars Work
One of the most common strategies that companies use to increase market share is to lower their prices. If competing companies also lower their prices, a price war can occur. Price wars most often strike industries where there is both heavy competition and several comparable products. Under these conditions, there is a large incentive for a competitor to cut prices in order to gain a greater share of the market.
The competing companies are often forced to follow suit and lower the prices of their products as well. As a result, the number of sales for the products increases, but each product is sold for a lower price–potentially leading to lower profits in the short term. At some point, one of the competing companies usually reaches its breaking point, meaning it can't afford to lower its prices more. Otherwise, they risk losing profits and potentially harming the long-term viability of the company. Companies with fewer financial resources may even be put out of business.
Oftentimes, lower prices are often accompanied by extra products or services or incentives to switch products. Some of the marketing strategies involved with gaining market share might include offering a free subscription-based service for one year, added services that come with a product purchase, or a buy-one-get-one-free (BOGO) offering. Whatever strategy is employed, the strategy behind a price war is to gain market share and in the process, 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 better deals. Also, consumers can benefit from additional products and services offered during a price war. For example, if car companies are engaged in a price war, consumers might be able to score a bargain price for a high-end model car that otherwise would have been too expensive. Additionally, consumers might also be able to get better financing or better service repair terms, such as a longer warranty—all thanks to the price war.
Companies and workers can benefit from price wars since the winner can become more financially profitable and ensure its longevity—leading to more jobs for the economy.
Disadvantages of Price Wars
However, 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 is no longer an established set of competitors. As a result, a company that has gained a sizable market share can raise prices at will–which can be a long-term consequence for consumers.
Also, workers are left with fewer companies in their local economy for which to work. The damage from price wars can be especially harsh in areas of the country that have only a few companies to employ people. With less competition, workers are forced to either accept lower-paying jobs or move to another area where jobs are more plentiful.
Consumers benefit from lower prices
Consumers also benefit from additional add-on services
Companies benefit by gaining new customers
Companies that lose a price war lose market share and profits
Price wars can lead to less competition and higher prices
Consumers have fewer choices for products and services
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 different strategies. For instance, one possible tactic is to differentiate the firm's product offering from that of the lower-cost firm. If a firm can offer a product that is unique or superior, or augment the value with future discounts and bundled freebies, then it will be in a much better position to preserve its pricing power.
Examples of Price Wars
Although price wars have typically consisted of companies offering commodity-style products, it has recently expanded to include companies offering a wide array of services. The marketing strategy includes lowering prices of products—allowing these companies to charge for service-related offerings at a later date.
Brokerage Price War
Brokerage firms were engaged in a price war throughout 2018 and 2019 in an attempt to gain customer deposits. Exchange-traded funds (ETFs) are extremely popular investment products for investors. ETFs are funds containing stocks or 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 no 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 has also moved to offer its ETFs with no trading fees.
For brokers like Schwab, the goal of a price war is to gain new clients and their deposits–allowing 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 lead up 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 the 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.