If you’ve been in the business game long enough, you will have heard of the term “price war”.

But does everyone in business actually understand the ramifications of starting or being involved in a price war? This is particularly important for those who don’t have some form of formal business education.

Bugs and Sparks founder and CEO, Craig Ford unpacks the pros and cons of price wars:

What is a price war?

A price war is a period of fierce competition in which traders cut prices in an attempt to increase their share of the market. In other words, a price war is commercial competition characterised by the repeated cutting of prices below those of competitors.

Essentially, one competitor will lower their price, then others will lower their prices to match it. If one of them reduces their price further, a new round of reductions starts, and so the process continues.

What causes price wars?

More often than not, price wars strike industries where both heavy competition and several comparable products exist. Under these conditions, there is a large incentive for a competitor to cut prices in order to gain a greater share of the market.

Left unchecked, a price war can spiral into a string of ever-lower price cuts that evaporate profit margins. Firms with fewer financial resources may even be put out of business.

Consumers and Price Wars

On the surface, lower prices mean a better deal for consumers. However, in some situations it can work the other way.

If a large firm can drive competitors out of business through aggressive price cutting, then consumers are left with fewer choices in the end. The remaining firms gain more pricing power over time, since there is no longer an established set of competitors.

Should businesses engage in price wars?

If your company brand is important to you, then the answer is no. “Temporary” price cuts tend to become “permanent.” Don’t damage your brand with a temporary price cut. If you try to compete on price in the short run, customers are going to be reluctant to go back to paying higher prices in the future.

Many companies often find that it is difficult to raise prices once customers get used to paying a lower price. And many “premium” brands find that their unique cachet disappears when their products start showing up in the bargain bin.

Ask the question: Is the juice worth the squeeze?

At the end of the day, you will never be the best in the world at “low prices.”

Just like the old saying goes, “no matter how good you are at something, there’s always someone in the world who’s better than you”. In the entire world, you are never going to be the lowest-price option. There will always be someone who is willing and able to go lower on price.

In the short term, price wars are good for consumers who can take advantage of lower prices. But it’s the businesses that feel the blows that price wars inflict: reduced profit margins and threats to their overall survival.

We are all competing on some level in a global or national market against large corporations with deep pockets. If price is the only selling point, none of us are going to survive for long.

Developing your Competitive Advantage to establish your company as a higher-value option

Ultimately, price only matters when there is no differentiation in the market – when the product is a commodity and all the options look the same. If consumers feel that they can get the same value for a lower price, they’ll take that deal.

You need to make sure your customers are aware of the better value that your product or service delivers – if customers value what you offer, they will pay a higher price. A prime example is an Apple phone that has a 60% profit margin.

Don’t try to compete on price; it’s ultimately a loser’s game. Instead, find out what you do better than anyone else in the world, and focus on that – your unique competitive advantage.

How firms like yours can respond

Price wars are almost always bad for firms. When firms have similar cost structures, cutting prices means cutting profit margins. But a price war can be difficult to address. If a competitor undercuts a company’s prices, the company’s most natural response is to match the new low prices. However, this may prompt the competitor to cut prices again, leading to a worse situation.

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 your company’s product offering from that of your lower cost competitor. If a competitor 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.

The Bottom Line

Healthy competition is good, but overly aggressive price wars can have negative long-term effects for both consumers and companies. There will always be a place for a low-cost leader, but other competitors can respond to price challenges more intelligently by differentiating their products and delivering a superior offering to consumers.