Price Wars

Definition

A price war is an economic conflict in which businesses repeatedly undercut each other's prices to capture a greater market share. It is a competitive strategy that occurs within a firm's micro-environment, specifically in the context of Porter's Five Forces analysis, where the intensity of rivalry among existing competitors is a key determinant of industry profitability.

5 Must Know Facts For Your Next Test

1. Price wars can lead to reduced profitability for all firms in an industry, as they compete to undercut each other's prices.
2. Firms may engage in price wars to try to gain a larger market share, but this can ultimately result in a race to the bottom where no firm is able to earn a decent profit.
3. The intensity of price competition is influenced by factors such as the number of competitors, the homogeneity of products, and the presence of high fixed costs.
4. Price wars can be difficult to escape, as firms may be reluctant to raise prices for fear of losing customers to competitors.
5. In some cases, price wars can lead to industry consolidation, as weaker firms are forced to exit the market or be acquired by larger, more dominant players.

Review Questions

• Explain how price wars relate to the intensity of rivalry among existing competitors, as described in Porter's Five Forces analysis.
  • According to Porter's Five Forces, the intensity of rivalry among existing competitors is a key determinant of industry profitability. Price wars are a manifestation of this intense rivalry, as firms repeatedly undercut each other's prices in an effort to capture a greater market share. The more homogeneous the products, the easier it is for customers to switch between competitors, and the more likely it is that firms will engage in price wars to maintain or grow their market position. The presence of high fixed costs can also contribute to the intensity of price competition, as firms try to maximize capacity utilization and spread their fixed costs over a larger volume of sales.
• Describe how price wars can lead to industry consolidation and the exit of weaker firms.
  • When firms engage in prolonged price wars, it can result in reduced profitability for all players in the industry. This can create a situation where weaker firms, unable to sustain the low prices and maintain profitability, are forced to exit the market or be acquired by larger, more dominant players. The industry may then consolidate, with a smaller number of firms controlling a greater share of the market. This consolidation can help to stabilize prices and restore profitability, but it may also lead to concerns about reduced competition and the potential for the remaining firms to engage in anti-competitive practices.
• Evaluate the potential long-term consequences of a prolonged price war for the firms involved and the industry as a whole.
  • A prolonged price war can have significant long-term consequences for the firms involved and the industry as a whole. In the short term, the intense competition and reduced profitability can strain the financial resources of all firms, potentially leading to the exit of weaker players. However, even the surviving firms may suffer from reduced investment in innovation, product development, and other strategic initiatives that are necessary for long-term competitiveness. The industry as a whole may become less attractive to new entrants, leading to a lack of innovation and reduced choice for consumers. Additionally, the remaining firms may be able to exercise greater market power, potentially leading to higher prices and reduced consumer welfare in the long run. Ultimately, while price wars may temporarily benefit consumers through lower prices, the long-term consequences can be detrimental to both firms and the industry as a whole.

Related terms

Competitive Pricing: The practice of setting prices in response to the prices charged by competitors, rather than based on the firm's own costs and demand.

Predatory Pricing: A pricing strategy in which a firm sets its prices at a very low level, often below cost, in order to drive competitors out of the market.

Market Share:

The percentage of a market's total sales volume that a particular company accounts for.