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Market analysis: How do price wars erupt?

In price wars, several competitors react to downward price changes by several markdown rounds that lead to overall lower prices in the marketplace. As has been noted in the past, once consumers have accustomed themselves to frequent promotions (expecting to buy at a low price), they are reluctant to pay the regular price again. This means that price wars ruin margins in the long run.

Oliver Heil and Kristiaan Helsen, two researchers from Mainz University and the Hong Kong University of Science and Technology, analysed a range of price wars across various industries such as logistics, grocery, software, food, etc. We believe that insights from their research, which appeared in the International Journal of Research in Marketing in 2001, are interesting for both brand manufacturers and retailers.

First, Heil and Helsen define several criteria how to identify price wars:

  • the players in the market focus predominantly on competitors rather than customers
  • the pricing interactions arising from the war harm the rivals
  • the rivals did not intend to initiate the price war
  • the pricing interactions violate industry norms
  • the pricing interactions occur more rapid than usual
  • prices go down primarily
  • interactions are not sustainable

Early warning signals of price wars

Overall, the researchers propose a range of scenarios which favor price wars:

  1. New entrants gaining significant market share. An example of this scenario is the price war between the Asian telecommunications company Singtel and StarHub, an international organization, and M1 Limitedan which once were new to the Singaporean market.
  2. Excess capacity in the industry. The researchers cite the automotive and transatlantic airline industry. A more recent example might be the solar industry, with Chinese manufacturers flooding the world markets with low-priced photovoltaic modules stemming from large volume fabs.
  3. Marginal or negative market growth, where firms have to steal market share in order to be able to grow.
  4. Market power is either highly concentrated or fragmented. The researchers here build on political science arguments, where highly concentrated power stimulates fear of hegemony, and highly fragmented power tempts expansion and aggression.
  5. High exit barriers. If firms have built e.g. a specific assets or a particular knowledge base that is not applicable elsewhere, they have little to lose when starting a war.
  6. Bad financial conditions. The reasons are similar like for high exit barriers.
  7. If competitive actions address a company’s most important product, the likelihood increases that it defends its position by reacting with price decreases that end up in a price war. Examples are price wars in the airline industry where price wars began on the most important routes.
  8. No clear price leader in the market. In contrary, when a single firm holds price leadership in the market, the players will take this firm as a reference value, potentially ignoring others.
  9. Commodity products facilitate price wars, while companies selling premium products are less prone to starting a war, as every price decrease deteriorates the image of the products that they are selling.
  10. Little brand loyalty. Price wars try to steal customers from competitors. If brand loyalty is high, stealing customers gets much more difficult.

Of course, multiple events may coincide, such as bad financial conditions due to overcapacity with high exit barriers, as could be found in the US airline industry over many years.

Heil and Helsen also noticed some characteristics of market players that have an impact on the course of the price war:

  • Retailers: If there are some firms in the market that have shown strong reactions to market events in the past and that have built up a reputation for toughness here, price wars tend to be more intense.
  • Customers: The higher price sensitivity of customers, the higher the likelihood of price wars, as in this case, market share is particularly volatile.

The researchers note that these conceptualizations are based on few observations, on the combination and adoption of similar situations in a different context, and partially on theoretical arguments that still wait to be confirmed on a larger scale.

Market Intelligence through Market analysis

Overall, we believe that companies should not only carefully monitor their competitors’ price setting activities, but also try to develop a much deeper understanding of the other players in the market in order to assess how far situations could lead to price wars. This means monitoring new competitive entry, financial conditions such as credit scores of the most important competitors, or competitive assortment analysis to identify dependence on specific product categories as well.

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