Under what environmental conditions are price wars most likely to occur in an industry? What are the implications of price wars for a company? How should a company try to deal with the threat of a price war?
Price wars are most likely to occur when the following conditions are present in an industry: the product is a commodity, exit barriers are substantial, excess capacity exists, the industry is consolidated, and demand is declining. A price war constitutes a strong threat. It is difficult for companies that market commodity-type products to build brand loyalty; therefore, competition tends to focus on price. High exit barriers make it hard for companies to eliminate excess capacity through plant closings. In turn, the persistence of excess capacity leads to price cuts, as companies strive to generate enough demand to utilize their ideal capacity and cover fixed costs. In a consolidated industry, interdependence implies that one company’s price cuts will elicit a response from its rivals, producing a downward spiral of prices. And it is declining demand that produces excess capacity and sparks off a price war in the first place. If all these conditions are present, a severe price war is likely.
Survival depends on a company’s ability to reduce operating costs and build brand loyalty so that it can retain its customers and still make profits when those of its competitors have dried up. Furthermore, the risk of a damaging price war can be reduced if the company can successfully enter into tacit price agreements with its competitors and if it can stress non-price factors when competing. As demand declines, however, tacit price agreements can be difficult to maintain. Finally, if excess capacity is the major reason for a price war, capacity reduction agreements between competitors, or mergers between competitors followed by the elimination of excess capacity, may be suitable strategies for attacking this problem.
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