Definition
A price war is a competitive exchange among businesses in which they continuously lower their prices to undercut their rivals and gain market share. It often happens in industries with many firms and identical products. While consumers might benefit from lower prices in the short term, price wars can lead to reduced profits for the companies involved and, in severe cases, may cause bankruptcy.
Key Takeaways
- Price War refers to a competitive situation where businesses continually lower their prices to undercut their competitors. It is often a strategy used to gain a larger market share or drive out competition.
- While price wars can provide consumers with lower prices in the short term, they can be detrimental to the businesses engaging in them, as it can lead to reduced profits and potentially loss of businesses in severe instances.
- It’s essential for companies that are considering a price war to analyze potential implications thoroughly. Other strategies that don’t involve direct price competition may provide sustainable advantages, such as focusing on service quality, innovation, or niche targeting.
Importance
The finance term “Price War” is important because it refers to a competitive exchange among rival companies who lower prices to undercut each other, aiming to attract consumers and gain market share.
While a price war can be beneficial for consumers due to reduced prices, it can simultaneously threaten the profitability of companies, particularly smaller businesses, if sustained for an extended period.
Similarly, repeated price wars can lead to commoditization where price becomes the only distinguishing factor among competitors.
Therefore, understanding price wars is essential for businesses to maintain a strategic balance between remaining competitive and ensuring long-term financial stability.
Explanation
A price war refers to a competitive exchange among rival companies who lower prices of their products or services to gain a strategic market advantage. The primary purpose of a price war is to drive competitors out of the market or create barriers to entry for potential new competitors.
Companies may do this in an attempt to increase their market share, the percentage of total sales in the market. As competitors strive to undercut each other, the price progressively reduces which may be a strategic move to eliminate or undermine price-based competition.
Price wars can be daunting for new businesses that may find it difficult to sustain profitability with the reduced pricing, but are generally beneficial for consumers who can take advantage of the lowered prices. However, while this results in immediate savings for customers, a sustained price war can lead to reduced competition in the long run, which could ultimately lead to price increases once the competition has been eliminated.
Therefore, while a price war can be an effective strategy for gaining a short term advantage, it may also negatively impact the industry’s profitability in the long term.
Examples of Price War
Airline Industry: In the United States during the 1970s and 1980s, a number of low-cost airlines like Southwest and People Express entered the market. They significantly reduced their air fares in an attempt to gain a larger share of the market. Established airlines had to respond by also lowering their prices to stay competitive, leading to a price war.
Smartphone Market: In the mid-2010s, Chinese smartphone manufacturers such as Xiaomi, Huawei, etc., began offering high-specification smartphones at a fraction of the price compared to big brands like Apple and Samsung. This led to an aggressive price war, where major brands were forced to offer better deals or lower their prices to retain their market share.
Supermarket Price Wars: These are common in the retail sector. In the UK for example, Aldi and Lidl offered discount prices as a strategy to gain market share from established supermarket chains like Tesco and Sainsbury’s. This led to a price war, where these supermarkets had to lower their prices in order to retain their customers and compete with these discount chains.
FAQs on Price War
What is a Price War?
A price war refers to a circumstances where competitors continuously lower prices for their services in an attempt to undercut each other and gain more customers. It typically happens in extremely competitive markets where there’s a high volume of similar products.
What are the causes of a Price War?
Market saturation, price sensitivity of customers, comparable products with little differentiation, and aggressive pricing strategies are some common causes of a price war.
What are the consequences of a Price War?
Although lower prices can initially attract customers, a price war can reduce profit margins for all competitors. In fact, if prices are dropped too significantly, companies may operate at a loss. Furthermore, it can also devalue products and services in the eyes of consumers.
How can a company survive a Price War?
In a price war, survival not only involves matching or beating competitors’ prices but also highlighting unique selling points or advantages of your products. Creating strong relationships with customers, focusing on quality, providing excellent customer service, and differentiation are the key to surviving a price war.
Is a Price War bad for the economy?
In the short term, consumers benefit from lower prices, but in the long run, a price war can lead to bankruptcy for businesses, job losses, and economic instability. Therefore, it is arguably bad for the economy.
Related Entrepreneurship Terms
- Competition Pricing
- Market Penetration
- Cost Leadership
- Predatory Pricing
- Undercutting
Sources for More Information
- Investopedia: A comprehensive online resource dedicated to investing and personal finance, where the term “Price War” is clarified in detail.
- The Economist: This UK-based newspaper, in its online form, offers authoritative insight and opinion on international news, politics, business, finance, science, technology and the connections between them.
- The Financial Times: This international daily newspaper, known for its global business coverage, features articles on various economic concepts including “Price War”.
- BBC Business: This section of the BBC News website provides some of the most reliable and updated news on finance subjects.
