By Akshay R. Rao, Mark E. Bergen and Scott Davis
IN THE BATTLE TO CAPTURE THE CUSTOMER companies use a wide range of tactics to ward off competitors. Increasingly, price is the weapon of choice – and frequently the skirmishing degenerates into a price war.
Creating low price appeal is often the goal, but the result of one retaliatory price slashing after another is often a precipitous decline in industry profits. Look at the airline price wars of 1992. When American Airlines, Northwest Airlines, and other U.S. carriers went toe-to-toe in matching and exceeding one another’s reduced fares, the result was record volumes of air travel-and record losses. Some estimates suggest that the overall losses suffered by the industry that year exceed the combined profits for the entire industry from its inception.
Price wars can create economically devastating and psychologically debilitating situations that take an extraordinary toll on an individual, a company, and industry profitability. No matter who wins, the combatants all seem to end up worse off than before they joined the battle. And yet, price wars are becoming increasingly common and uncommonly fierce. Consider the following two examples:
• In July 1999, Sprint announced a nighttime long-distance rate of 5 cents per minute. In August 1999, MCI matched Sprint’s off-peak rate. Later that month, AT & T acknowledged that revenue from its consumer long-distance business was falling, and the company cut its long-distance rates to 7 cents per minute all day, everyday, for a monthly fee of $ 5.95. AT & T’s stock dropped 4.7% the day of the announcement. MCI’s stock price dropped 2.5%; Sprint’s fell 3.8%.
• E-Trade and other electronic brokers are changing the competitive terrain of financial services with their extraordinarily low-priced brokerage services. The prevailing price for discount trades has fallen from $30 to $ 15 to $ 8 in the past few years.
There is a little doubt, in the first example, that the major players in the long-distance phone business are in a price war. Price reductions per-second billing, and free calls are the principal weapons the players bring to the competitive arena. There is little talk from any of the carriers about service, quality, brand equity, and other nonprice factors that might add value to a product or service. Virtually every competitive move is based on price, and every countermeasure is a retaliatory price cut. Akshay R. Rao is an associate professor and coordinator of the doctoral program in the department of marketing at the University of Minnesota’s Carlson School of Management in Minneapolis. Mark, E. Bergen is an associate professor of marketing at the Carlson School. Scott Davis is principal and founder of Strategic Marketing Decisions, a consultancy in Sacramento, California.
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Price wars are becoming more common because managers tend to view a price change as an easy, quick, and reversible action
In the second example, the competitive situation is subtly different – and yet still very much a price war. E-Trade’s success demonstrates how the emergence of the Internet has fundamentally changed the cost of doing business. Consequently, even businesses such as Charles Schwab, which used to compete primarily on low-price appeal, are chanting a “quality” mantra. Meanwhile, Merrill Lynch and American Express have recognized that the emergence of the Internet will affect pricing and are changing their price structures to include free online trades for high-end customers. These companies appear to be engaged in more focused pricing battles, unlike the “globalized” price war in the long-distance phone market.
Most managers will be involved in a price war at some point in their careers. Every price cut is potentially the first salvo, and some discounts...