What is a Price War
A price war is a competitive exchange among rival companies who lower prices to undercut one another. A price war may be used to increase revenue in the short term, or as a longer-term strategy to gain market share. Price wars can be prevented through strategic price management (with non-aggressive pricing), a thorough understanding of the competition, or even communication with competitors.
BREAKING DOWN Price War
When a company wants to increase market share, usually the easiest way is to reduce prices, which increases product sales. The competition may be forced to follow suit if its products are similar. As prices get lower, the quantity of sales increases, and customers receive the benefits. Eventually, a price point is reached that only one company can afford. Some companies will even sell at a loss in an attempt to eliminate the competition completely.
What Can Trigger a Price War
Price wars may be driven by competition among companies that are local to each other and want to dominate the geographic footprint they mutually occupy and serve. With online businesses, price wars might be started with online as well as offline companies that want the same demographic of customers.
Companies that engage in price wars make a choice to diminish or even eliminate their current profit margins to attract more customers. In order to mitigate these effects, a company might have an arrangement with its suppliers to procure materials or finished products at a deep discount compared with its rivals. That would enable the company to cut its prices to customers much lower, and for longer periods than compared with rivals. In such instances, the supplier might actually suffer the loss rather than the company that is engaged in the price war. Businesses that move large quantities of products may have the buying power to leverage such agreements.
For example, a national big box retailer who sells vast volumes of a product through its locations across country might have a deal with the supplier to fill its inventory at a discount. That would let this major retailer sell the product below market prices. In response, local retailers who compete with the big box retailer may try to offer short-term discounts to customers. The big box retailer could escalate the situation to a price war, cutting its prices even lower than the local retailers can afford to match. Such practices, if maintained for extended periods, could eventually force local retailers to go out of business.