Price War

What Is a Price War?

A price war is a competitive exchange among rival companies who lower the price points on their products, in a strategic attempt to undercut one another and capture greater market share. A price war may be used to increase revenue in the short term, or it may be employed as a longer-term strategy.

Price wars can be prevented through strategic price management, that relies on non-aggressive pricing, a thorough understanding of the competition, and even robust communication with competitors.

Price wars should be entered into cautiously because pricing most significantly impacts a company income statement's bottom line; a 1% price drop can slash profits by more than 10%.

Understanding Price Wars

When a company seeks to increase market share, the easiest way typically is to reduce prices, which subsequently increases product sales. The competition may be forced to follow suit if it sells similar products. And as prices drop, the quantity of sales increases, which consequently benefits customers.

Eventually, a price point is reached that only one company can afford to offer, while still remaining profitable. Some companies will even sell at a loss in an attempt to eliminate the competition completely.

Special Considerations: What Can Trigger a Price War

Price wars may be driven by competition among companies that are local to one other, who wish to dominate the geographic footprint they mutually occupy. With online businesses, price wars might be started via online platforms that wish to take business away from brick-and-mortar companies that target the same consumer demographics and are attempting to sell similar products.

Companies that engage in price wars make a concerted choice to diminish or eliminate their current profit margins, in an effort to attract more customers. In order to mitigate these effects, a company might cultivate an arrangement with its suppliers to procure materials or finished products at a deep discount, compared to the prices the suppliers charge rival businesses. This practice enables the company to drastically cut its prices to customers, for longer time periods than the competition.

In such scenarios, the supplier might actually suffer the loss, rather than the company that's engaged in the price war. But businesses that move large quantities of products may have the buying power to leverage such agreements.

Key Takeaways

  • A price war refers to the action of two rival companies who both lower the prices on products, in an attempt to undercut one another and capture greater market share.
  • Companies that participate in price wars make an explicit choice to slash current profit margins, in an effort to attract more customers for the short term.
  • To stay profitable during a price war, a company might arrange to purchase materials from suppliers at significant discounts.

For example, a national big-box retailer who sells vast volumes of a product through its locations across the country might have a deal with the supplier to fill its inventory at a discount. That would let this retailer move the product at below-market prices.

In response, local competitive retailers may try to offer short-term discounts, to attract customers. The big-box retailer could then escalate the situation, to a full-on price war, cutting its prices even lower than the local retailers are capable of matching. Such practices, if maintained for extended periods, could eventually force local retailers out of business.