facing a price war, you'll need to understand how it started in order to respond effectively. Often the best counterattack does not. involve a retaliatory price
1^ f Scott Davis
by Akshay R. Rao, Mark E. Bergen, and
HARVARD BUSINESS REVIEW March-April 2000
N 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, hut the result of one retaliatory price slashing after another is often a precipitous decline in industry profits. Look at the airline price wars of r992. 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 hy the industry that year exceed the combined profits for the entire industry from its inception. Price wars can create economically devastating and psychologically dehilitating situations that take an extraordinary toll on an individual, a com-
How to Fight a Price War
pany, and industry profitability. No matter who wins, the comhatants 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 longdistance rate of 5 cents per minute. In August 1999, MCI matched Sprint's off-peak rate. Later that month, ATikT 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 $ 5.9 5. 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 hrokers are changing the competitive terrain of financial services with their extraordinarily low-prieed brokerage services. The prevailing price for discount trades has fallen from $30 to $15 to $8 in the past few years. There is 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 ealls are the principal weapons the players hring to the competitive arena. There is little talk from any of the carriers ahout service, qual-
a "quality" mantra. Meanwhile, Merrill Lynch and American Express have reeognized 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 "glohalized" 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 routinely lead to retaliatory price cuts that then escalate into a full-blown price war. That's why it's a good idea to consider other options before starting a price war or responding to an aggressive price move with a retaliatory one. Often, companies can avoid a debilitating price war altogether by using a set of alternative tactics. Our goal is to describe an arsenal of weapons other than price cuts that managers who are engaged in or contemplating a price war may also want to consider.
Generally, price wars start because somebody somewhere thinks prices in a certain market are too high. Or someone is willing to buy market share at the expense of current margins. Price wars are becoming more common because managers tend to view a price change as an easy, quick, and reversihle action. When businesses don't trust or know one another very well, the pricing battles can escalate very quickly. And...