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 to price wars for the companies involved as well as the consumers being courted.

Key Takeaways

  • 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 companies 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 their prices any lower. 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.

Often times, 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 employed, the strategy behind a price war is to gain market share and in the process, hurt the competition.

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 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.

Pros

  • Consumers benefit from lower prices

  • Consumers also benefit from additional add-on services

  • Companies benefit by gaining new customers

Cons

  • 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 in the Harvard Business Review argues that the best response to a price war is to try to sidestep this type of direct conflict by employing 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 in some way, unique or superior, 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 2108 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 transaction 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.

Airline Price War

The airline industry is a classic example of an environment for price wars. Air travel is viewed by consumers as a commodity product–transportation from point A to point B. Since the service offerings of different airlines are so similar, consumers look primarily at price when they buy. This has led to virtually continual fare wars in different markets around the world. A widespread fare war in 1992 cost the U.S. airline industry more than $4 billion in just a few months, according to The New Yorker.