if you find yourself facing a price war, you'll need to ...€¦ · response to a...

If you find yourself

facing a price war,you'll need tounderstand how itstarted in order torespond effectively.Often the bestcounterattack doesnot. involve aretaliatory price

How

by Akshay R. Rao,Mark E. Bergen, and

^ 1 1^ f Scott DavisWarI

N THE BATTLE TO CAPTURE THE CUSTOMER,

companies use a wide range of tactics to wardoff competitors. Increasingly, price is theweapon of choice - and frequently the skir-mishing degenerates into a price war.

Creating low-price appeal is often the goal, hut theresult of one retaliatory price slashing after anotheris often a precipitous decline in industry profits.Look at the airline price wars of r992. When Ameri-can Airlines, Northwest Airlines, and other U.S.carriers went toe-to-toe in matching and exceedingone another's reduced fares, the result was recordvolumes of air travel-and record losses. Some esti-mates suggest that the overall losses suffered hy theindustry that year exceed the combined profits forthe entire industry from its inception.

Price wars can create economically devastatingand psychologically dehilitating situations thattake an extraordinary toll on an individual, a com-

HARVARD BUSINESS REVIEW March-April 2000 107

How to Fight a Price War

pany, and industry profitability. No matter who wins,the comhatants all seem to end up worse off thanbefore they joined the battle. And yet, price wars arebecoming increasingly common and uncommonlyfierce. Consider the following two examples:• In July 1999, Sprint announced a nighttime long-

distance rate of 5 cents per minute. In August1999, MCI matched Sprint's off-peak rate. Laterthat month, ATikT acknowledged that revenuefrom its consumer long-distance business wasfalling, and the company cut its long-distancerates to 7 cents per minute all day, everyday, for amonthly fee of $ 5.9 5. AT&T's stock dropped 4.7%the day of the announcement. MCI's stock pricedropped 2.5%; Sprint's fell 3.8%.

• E-Trade and other electronic hrokers are changingthe competitive terrain of financial services withtheir extraordinarily low-prieed brokerage ser-vices. The prevailing price for discount trades hasfallen 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 busi-ness are in a price war. Price reductions, per-secondbilling, and free ealls are the principal weapons theplayers hring to the competitive arena. There is lit-tle talk from any of the carriers ahout service, qual-

Price wars are becoming morecommon because managers tendto view a price change as an easy,

quick, and reversible action.

ity, brand equity, and other nonpriee factors thatmight add value to a product or service. Virtuallyevery eompetitive move is based on price, and everycounter measure is a retaliatory price cut.

In the second example, the competitive situationis subtly different - and yet still very much a pricewar. E-Trade's success demonstrates how the emer-gence of the Internet has fundamentally changedthe cost of doing business. Consequently, evenbusinesses such as Charles Schwab, which used tocompete primarily on low-price appeal, are chanting

Aksbay R, Rao is an associate professor and coordinatorof the doctoral program in the department of marketingat the University of Minnesota's Carlson School of Man-agement in Minneapolis. Mark E. Bergen is an associateprofessor of marketing at the Carlson School. Scott Davisis principal and founder of Strategic Marketing Deci-sions, a consultancy in Sacramento, California.

7b discuss this article, join HBR's authors and readers inthe HBR Forum at w'ww.hbr.org/forum.

a "quality" mantra. Meanwhile, Merrill Lynch andAmerican Express have reeognized that the emer-gence of the Internet will affect pricing and arechanging their price structures to include free on-line trades for high-end customers. These compa-nies appear to be engaged in more focused pricingbattles, unlike the "glohalized" price war in thelong-distance phone market.

Most managers will be involved in a price war atsome point in their careers. Every price cut is po-tentially the first salvo, and some discounts rou-tinely lead to retaliatory price cuts that then esca-late into a full-blown price war. That's why it's agood idea to consider other options before startinga price war or responding to an aggressive pricemove with a retaliatory one. Often, companies canavoid a debilitating price war altogether by using aset of alternative tactics. Our goal is to describe anarsenal of weapons other than price cuts that man-agers who are engaged in or contemplating a pricewar may also want to consider.

Take InventoryGenerally, price wars start because somebodysomewhere thinks prices in a certain market aretoo high. Or someone is willing to buy marketshare at the expense of current margins. Price warsare becoming more common because managerstend to view a price change as an easy, quick, andreversihle action. When businesses don't trust orknow one another very well, the pricing battles canescalate very quickly. And whether they play out inthe physical or the virtual world, price wars have asimilar set of antecedents. By understanding theircauses and characteristics, managers can make sen-sihle decisions about when and how to fight a pricewar, when to flee one-and even when to start one.

The first step, then, is diagnosis. Consider a smallcommodities supplier that suddenly found that itslargest competitor had slashed prices to a level wellbelow the small company's costs. One option thesmaller company considered was to lower its pricein a tit-for-tat move. But that price would have heenbelow the suppher's marginal cost; it would havesuffered debilitating losses. Fortunately, a fewphone calls revealed that its adversary was attempt-ing to drive the supplier out of the local market byunderpricing its products locally but maintaininghigh prices elsewhere. The supplier correctly diag-nosed the pricing move as predatory and elected todo two things. First, the manager called customersin the competitor's home market to let them knowthat the price-cutter was offering special deals inanother market. Second, he called local customers

108 HARVARD BUSINESS REVIEW March-April 2000


and asked them for their support,pointing out that if the smaller sup-plier was driven off the market, itscustomers would be facing a monop-olist. The short-term price cuts wouldturn into long-term price hikes. Thesupplier identified solutions that es-chewed further price cuts and thusaverted a price war.

Intelligent analysis that leads to ac-curate diagnosis is more than half thecure. The process emphasizes under-standing the opportunities for pric-ing actions hased on current markettrends and responding to competitors'actions hased on the players and theirresources. Not only is it necessary tounderstand why a price war is occur-ring or may occur, it also is critical torecognize where to look for the re-sourees to do hattle.

Good diagnoses involve analyzingfour key areas in the theater of opera-tions. They are customer issues suchas price sensitivity and the customersegments that may emerge if priceschange; company issues such as abusiness's cost structures, capabili-ties, and strategic positioning; com-petitor issues, such as a rival's coststructures, capabilities, and strategicpositioning; and contributor issues,or the other players in the industrywhose self-interest or profiles may affect the out-come of a price war. [For a more detailed explana-tion of sueh analyses, see the sidebar "Analyzingthe Battleground.")

Companies that step back and examine those fourareas carefully often find that they actually havequite a few different options -including defusing theconfiict, fighting it out on several fronts, or retreat-ing. We'll look at some of those strategies and howcompanies have deployed them successfully.

Stop the War Before It StartsThere are several ways to stop a price war before itstarts. One is to make sure your competitors under-stand the rationale behind your pricing policies. Inother words, reveal your strategic intentions. Price-matching policies, everyday low pricing, and otherpuhlic statements may communicate to competi-tors that you intend to fight a price war using allpossible resourees. But frequently these declara-tions about low prices, or about not engaging in

Ways to Fight a Price War

Nonprice Responses

Reveal your strategicintentions and capabilities

Compete on quality

Co-opt contributors

Offer to match competitors'prices, offereveryday low pricing, or reveal your costadvantage

Increase product differentiation by addingfeatures to a product, or build awarenessof existing features and their benefits.Emphasize the performance risks in low-priced options.

Form strategic partnerships by offeringcooperative or exclusive deals withsuppliers, resellers, or providers of relatedservices

Price Responses

Use complex price actions

Introduce new products

Deploy simple priceactions

Offer bundled prices, two-part pricing, 1quantity discounts, price promotions, or 1loyalty programs for products 1

Introduce flanking brands that compete 1in customer segments that are being 1challenged by competitors 1

Adjust the product's regular price in 1response to a competitor's price change or Ianother potential entry into the market 1

price promotions, aren't low-price strategies at all.Such announcements are simply a way to tell com-petitors that you prefer to compete on dimensionsother than price. When your competitors agree thatsuch competition will be more profitable than com-peting on price, they'll tend to go along. That is pre-cisely what happened when Winn-Dixie followedthe Big Star supermarket chain in North Carolinaand announced that it, too, would meet or beat mu-tual rival Food Lion's prices. After two years, thenumher of equipriced products among 79 commonlypurchased brand items at the supermarkets hadmore than doubled. Further, the overall marketprice level had increased for these products. Whathappened? The stores stopped competing on price.In fact, the data suggest that Food Lion raised itsprices after its competitors announced they wouldmatch Food Lion's prices.

Making sure that your competitors know thatyour costs are low is another option -one that effec-tively warns them about the potential conse-quences of a price war. Hence it sometimes pays to



zeveal yom cost advantage. Sara Lee has low vari-able costs, yet its products are relatively high prieedcompared with those of competitors. In the event ofa price war, Sara Lee can drop its prices to levelsthat its competitors can't profitably match. Thecommon knowledge ahout this low cost detersprice cutting from competitors.

Sara Lee's management realizes that price cutswould be inconsistent with its strategic position ofbrand differentiation. Rather than use its low-coststructure to compete on price to build market share,Sara Lee uses its low costs as an implicit threat thathelps prevent priee wars. Essentially, a businessthat has relatively low variahle costs enjoys an en-viable advantage in a price war since competitorscannot sustain a price below their own variahlecosts in the long run. But low-cost companiesshould carefully consider their strategic positionsbefore they start or join a price war. Lower costsoften tempt a business to cut its prices, but doing socan diminish consumers' perceptions of quality andmay trigger an unprofitable price war.

Responding with Nonprice ActionsSometimes an analysis of the market reveals thatseveral customer segments exhibit different degreesof sensitivity to price and quality. (See the sidebar"Priee Sensitivity on the Weh" for a look at howmanagers can identify and exploit differences incustomers' price sensitivities - even in an informa-tion-rich environment.) Understanding the hasisfor certain customers' price sensitivities lets man-agers creatively respond to a rival's price cut with-out cutting their own prices. For example, a com-pany might be able to focus on quality, not price.

Southeast Asia went through a rough time in1997, particularly in the luxury product and serviceareas. The region's economy was unstahle, Indone-sian forest fires were wreaking havoc with the smogindex, and tourism was clearly suffering. The eco-nomic turmoil dramatically reduced the value ofthe Malaysian ringgit to about half its value a fewyears earlier. The cost of a hotel room plummetedalong with the nose-diving currency, yet hotel roomswent a-hegging, What did the luxury hotel opera-tors do to attract customers? They dropped theirroom rates even further. Luxury hotels in Malaysiaentered a price war. All but one.

The Ritz-Carlton chose to steer clear of the fray.Instead, fames McBride, the hotel's general manager,became creative. He greeted arriving flights withmusic, mimosas, discount coupons, and a modelroom. Passengers with reservations at other hotelsbegan to defect to the Ritz at alarming rates. McBride

Price Sensitivity on the Web

Internet companies such as Buy.com are attempting tobuild market share by charging low prices. They operateunder the premise that Internet shoppers are extremelysensitive to price. But the evidence to back up that as-sumption is mixed. On the one hand, the Web offers aneasy way to search and compare prices. On the otherhand, on-line shoppers tend to search for quality attri-hutes, as well. Professors John G. Lynch of Duke Univer-sity's Fuqua School of Business and Dan Ariely of MIT'sSloan School of Management have recently demon-strated that making quality information more accessibleon the Web reduces price sensitivity.' That is why Ama-zon.com can charge higher prices than other on-linesites. The variety of titles it offers, the extensive prod-uct information it provides, and its reputation forrapidand reliable shipping make Amazon an easy choice forconsumers who want convenience and low prices,

The growth of Internet shopping is posing interest-ing pricing dilemmas for hricks-and-mortar retaileiis.On-line vendors don't have to maintain a physical pres-ence close to their customers, so they can operate outof a few large warehouses, thus lowering their costs. Itwould generally be unwise for hricks-and-mortar retail-ers to try to compete on price given the relatively highcost of maintaining a storefront. Instead, their strategyshould emphasize features that can't be provided overthe Web, such as personahzed face-to-face service,hrowsing, immediate delivery, low-hassle returns andexchanges that don't require repackaging and shipping,and the ahility to touch the product. Several retailers,such as Barnes & Nohle and Tower Records, have devel-oped an Internet presence to complement their store-fronts. Sucb "clicks and mortar" retailers give customersthe option to purchase or order on-line and then pick upthe product at a hricks-and-mortar hranch, and thoseretailers often provide a search engine in the store thatis similar to their Internet offerings.

Finally, a keen understanding of consumer hehaviorlets some companies charge higher prices on the Wehhecause of the anonymity that on-line transactionsoffer. In a recentstudyof 46 e-tailers of prescriptiondrugs, the two most popular items (Viagra, a medica-tion for erectile dysfunction, and Propecia, a medicationto treat male pattern baldness) were priced roughly io7ohigher than in drug stores. For obvious reasons, peopleprefer to have those prescriptions filled without personalcontact and are willing to pay a premium for a facelesstransaction.

1. See "Wine Online^ Search Costs and Competition on Price, Quality,iun,' Marketing Science, 3000.

110 HARVARD BUSINESS REVIEW March-April 2000


provided his cellular phone number in newspaperads so people could call him directly for reserva-tions. Guests had round-the-clock access to a "tech-nology hutler" who could fix laptops and other elec-tronic devices. The Ritz offered a "bath menu" ofdrinks and snacks to he served along with butler-drawn baths. Guests who stayed more than fivenights received an embroidered pillowcase.

When luxury hotels start cutting their guest rates,their ability to offer "luxury" accoutrements drops.That means no fresh flowers,fewer towels, and a noticeableshortage of staff. But the Ritzkept its rates ahove 200 ringgit(ahout $52 U.S.) and was ahle topay for low-cost serviees such asproviding the emhroidered pil-lowcases. Most important, theRitz avoided any damage to itshrand equity, something thatcould have easily occurred if typ-ical Ritz customers arrived atthe hotel and found it filled withnoisy hackpacking tourists orlarge families, all taking advantage of low prices.The negative spillover onto other Ritz propertiescould have been significant.

The Ritz-Carlton Kuala Lumpur last fall had nomore empty rooms than its competitors; in fact,occupancy rates were up to 60% compared with a50% occupancy rate in 1998. Perhaps most impor-tant, monthly gross operating profit on revenue of2.2 milUon ringgit is about 400,000 ringgit -a returnof about 18%.

Another way companies can avoid a price war isto alert customers to risA-specifically, the risk ofpoor quality. A senior product manager from theEuropean operation of a large multinational phar-maceutical corporation lamented her recent pricingpredicament. Her company's product, a medical di-agnostic device, was the market-share leader, but arival company had recently become aggressive onprice. "They're crazy! Don't they see what they'redoing to profits in the industry? Nobody can makemoney at these prices. What should I do? I've triedeverything, and I can't get them to see the error oftheir ways," she said.

Not surprisingly, research confirmed that a largesegment of customers in this "life and death" in-dustry-doctors and testing laboratories-was quiterisk averse and sensitive to variations in a product'sperformance. So rather than compete on price, themultinational appealed to customers' concernsabout performance by emphasizing product en-hancements such as improved reliahility and

One way companies canavoid a price war is to

alert customers to risk -specifically the risk ofpoor product quality.

A related weapon is toemphasize other negative

consequences.

greater detail in the information generated hy thediagnostic device and by alerting buyers to the neg-ative consequences of incomplete diagnoses. Somesales were lost to lower-priced products from thecompetitor, but the quality-sensitive segment al-lowed the multinational to maintain reasonablemargins and avoid the negative spiral of a price war.

Federal Express provides another good example ofhow a company can appeal to performance sensitiv-ity among customers. FedEx's brand equity exceeds

that of virtually any company inthe package delivery business.The shipping giant has huilt anenviable level of consumer re-call and recognition through ahighly effective advertising cam-paign. By emphasizing in adsand through other marketingefforts that a customer's pack-age will "absolutely, positively"

customers' risk aversion whendealing with time-sensitivedocuments.

A related weapon that eompanies can use to avertor battle a price war is to emphasize other negativeconsequences. The NutraSweet company employedthis strategy when it faced the expiration of itspatent. The company feared considerable price pres-sure from the producers of aspartame, the genericversion of NutraSweet. A worst-case scenario wouldinvolve one of NutraSweet's major customers, suchas Coca-Cola or Pepsi, switching to aspartame. Ifone of the companies switched, NutraSweet's con-tingency plan-which it shared with wavering Cokeand Pepsi executives in Atlanta and New York-wasa week-long advertising blitz that would alert con-sumers that "the other cola" was the only one thatcontained NutraSweet. Given the size of the marketfor carbonated soft drinks, NutraSweet's brand eq-uity in the diet-conscious segment, and the poten-tial short-term loss in market share and profits, thisthreat had teeth. NutraSweet successfully playedone customer against another, emphasizing direand unpalatable consequences, and thus averted adehilitating price war.

A final nonprice option involves seeking help, orappealing to contributors to weigh in on the com-petitive situation. For instance, when Sony enteredthe market for high-end imaging systems, the lead-ers in the imaging systems market in Belgium ap-pealed to and received help from the central Bel-gian government. Not all companies can count onthe government to come to their aid, of course. Socompanies might appeal to customers, vendors,



channel partners, independent sales representa-tives, and other like-minded players if the pricewar could mean the company's demise. For in-stance, in the 1990s, Northwest Airlines appealedto its labor unions and received dramatic wage con-cessions'so it eould compete on price in a tight air-travel market.

Using Selective Pricing ActionsEmploying complex options such as multiple-partpricing, quantity discounts, time-of-use pricing,bundling, and so on lets price warriors selectivelycut rates for only those segments of the populationthat are under competitive threat.

One common-and classic-tactic is to changecustomers' choices, or reframe the price war in theminds of customers. McDonald's did it successfullywhen it faced Taco Bell's S9-cent taco strategy inthe r98os. By bundling burgers, fries, and drinksinto "value meals," McDonald's reframed the pricewar from "tacos versus burgers" to "lunch versusluneh." Similarly, smart managers use quantity dis-counts or loyalty programs to insulate themselvesfrom a price war. They avoid across-the-hoard pricecuts, and they limit price reductions to areas inwhich they are vulnerahle. In this way, managerscan localize a price war to a limited theater of oper-ation ~ and cut down the opportunities for the warto spill into other markets.

Therefore, another selective-pricing tactic mighthe to modify only certain prices. For instance. SunCountry Airlines, a discount carrier, entered North-west's Minneapolis-St. Paul hub with 16 planesproviding service to 14 cities. Sun Country's round-trip airfare to any location was generally low: Min-neapolis to Boston was roughly S308. Rather thanengage in a systemwide priee cut. Northwest re-

Managers can localize a price warto a limited theater of operation - and

cut down the opportunities for thewar to spill into other markets.

tained its existing fare structure with minor modi-fications. A Minneapolis-Boston round-trip was arelatively low $310 if tickets were purchased sevendays in advance-but only for a flight that departedat 7:10 AM and returned at 11:10 AM. Curiouslyenough. Sun Country's only flight on that route de-parted Minneapolis at 7 AM and Boston at 11:2O AM.Northwest also employed several other resources,sueh as travel agents, to fend off Sun Country.

Northwest reasoned that Sun Country did not havethe infrastructure necessary to engage in an all-outprice war and chose to not engage in any preemp-tive price cutting at times other than the flightsdirectly affected. By targeting only certain fares fordiscounts. Northwest minimized internal changeshut could still counter Sun Country's pricing ploy.

On another selective-pricing front, companiesmay use a fighting brand. In the early 1990s, KaoCorporation entered the diskette market with alow-priced product. Rather than drop its priees, 3Mlaunched a fianking hrand of low-priced diskettescalled Highland hecause it knew that a large groupof its customers was loyal to the 3M brand. Simplydropping the price on the 3M brand might have di-luted 3M's quality image and its profits and mayhave stimulated further price cuts hy Kao.

Because it understood its customers, 3M knewthat many different segments of price-sensitivecustomers existed. Some people buy cheap dis-kettes, and some people don't care how much theypay for diskettes. More important, some peoplethink cheap diskettes are probably of poor quality,and they may not huy them if the price is too low-perhaps hecause they are terrified of losing theirdata. 3M avoided the trap of charging what the mar-ket will bear. It recognized that markets will bearmany prices, some better than others. That insightunderpins the strategies of many software com-panies. For instance, marginally different versionsof the same voice-recognition software can rangein price from $79 to $8,000 depending on who thehuyeris.'

You may not need a new brand to counter a pricecut, just a new package. Consider the case of a ma-jor consumer-products company that faced an ag-gressive price-cutting competitor. The defendingcompany finally dropped the price of its economy-size product with a "buy one, get one free" offer.Since the economy-size product lasts six months,the company took high-volume, price-sensitiveusers off the market for nearly a year. The resultinglow sales of the competitor's product convinced therival to cease and desist.

That illustration has several instructive elementsto it. First, an acute understanding of the competi-tor's abilities, motives, and mind-set allowed thedefending company to react effectively to a pricewar. Second, the expertise was complemented witha clear understanding of consumer behavior thatallowed the company to prevent a price war. Third,the new entrant clearly picked the wrong adver-sary. The defending company was willing to suffersome losses (through cannihalization) in order toprotect its turf.

114 HARVARD BUSINESS REVIEW Match-April 2000


Companies may also opt to cut prices in certainchannels. Perhaps the single largest driver of pricecuts and resulting price wars is excess capacity. Thetemptation to revive idle plants hy stimulating de-mand through lower prices is often irresistihle. Butsmart managers consider other options fiirst. For in-stance, companies in the packaged-goods industryfrequently sell off-hrand or private-lahel versions oftheir national hrands at low prices, ensuring thatany price wars won't damage the hrand equity ofthe national hrands.

Similarly, airlines such as Delta are making adent in reducing their unsold inventory hy offering

hard drive, and a host of other functions for roughly$400. High-profile brands such as HP and IBM areheing forced to consider pricing their PCs in the$500 range to reach the first-time huyer. In thismarket, price cuts appear to be the only way tocompete. In fact, "free PCs" are availahle to con-sumers who are willing to he exposed to a signifi-cant amount of advertising.

Clearly there are times when you must engage ina preemptive strike and start a price war-or re-spond to a competitor's discount with a matchingor deeper price cut of your own. For instance, whena competitor threatens your core husiness, a retalia-

If simple retaliatory price cuts are the chosen means of defense in a price wanimplement them quickly and unambiguously so competitors will know

that their sales gains will be short-lived.

seats to consolidators and auction houses such asPriceline.com and Cheaptickets.com. The airlinesare selling tickets to price-sensitive customers whodon't'care about flight times, numher of stops, orfrequent-flyer miles. Because the customer's pointof contact is with the consolidator and not with theairline, the airline's image is protected- in muchthe same way that a nationally branded soup manu-facturer protects its image by selling excess capac-ity under a private label.

But engaging in "stealth marketing" by sellinglow-priced, functionally equivalent alternativesthrough unrelated brand names or in foreign mar-kets may still trigger price wars. If consumers rec-ognize that the quality of the private-label productis comparable to that of the branded option, thenthe price of the hranded option will need to drop. Inmany cases, it is best to leave plant capacity idle,since the attempt to revive it may trigger margin-destroying price competition. In fact, the idle ca-pacity can be used as a weapon; a company thenwields the credible threat of being able to flood themarket with cheaper products should a competitorstart cutting its prices.

Fight It OutAlthough we feel strongly that direct, retaliatoryprice cuts should be a last resort, we do recognizethat it is sometimes simply impossible to avoida price war. Consider the case of personal comput-ers. Expansion in this industry is occurring primar-ily at the low end as more and more price-sensitiveconsumers enter the market for PCs. EMachines,in Irvine, California, sells PCs that feature Intel'sCeleron processor (a 366 MHz chip), a 4.3 gigabyte

tory price cut can be used to signify your intentionto fight long and hard. Similarly, when you canidentify a large and growing segment of price-sensi-tive customers, when you have a cost advantage,wben your pockets are deeper than competitors'pockets, when you can achieve economies of scaleby expanding the market, or when a rival can beneutralized or eliminated because of high barriersto market entry and reentry, then engaging in pricecompetition maybe smart.

But there are several long-run implications ofcompeting on price. First, a pattern of price cuttingmay teach customers to anticipate lower prices;more patient customers will defer their purchasesuntil the next price cut. Second, a price-cuttingcompany develops a reputation for being low-priced, and this reputation may cast doubt on thequality and image of other products under the um-brella brand and on the quality of future products.Third, price cuts have implications for other play-ers in the market, whose self-interest may beharmed hy lower prices.

If simple retaliatory price cuts are the chosenmeans of defense in a price war, then implementthem quickly and unambiguously so competitorsknow that their sales gains from a price cut will beshort-lived and monetarily unattractive. A slow re-sponse may prompt competitors to make additionalprice cuts in the future.

RetreatOn rare occasions, discretion is the hetter part ofvalor. Consequently, some husinesses choose notto fight price wars; instead, they'll cede some mar-ket share rather than prolong a costly battle. 3M



and DuPont are both companies that focus on de-veloping innovations as part of their core strategy-and both have proved willing to cede share ratherthan participate in an unprofitable price war. Infact, 3M takes pride in the fact that roughly 40% ofits revenue five years from now will come fromnew products. And in cases where it has retreatedfrom pricing battles rather than standing its ground,the company seems to have come out ahead. For in-stance, because of withering price competitionfrom high-volume, low-margin suppliers, 3M with-drew from the videotape business in the mid-1990s-even though videotape was invented at 3M.Similarly, Intel stopped manufaeturing DRAMchips in the face of intense price competition fromTaiwanese manufacturers in the 1980s, and its fo-cus on processor chips has served it well. AndCharles Schwab's decision to avoid a price war withlow-priced Internet brokers has served stockhold-ers well - the value of their Schwah holdings hasmore than quadrupled in the past two years.

It's Never Too Early to PrepareIt's in companies' best interests to reduce pricecompetition because price wars can harm an entireindustry. But diplomatic resolutions of price warsare generally impossible be-cause overt diplomacy is aform of price collusion andmay attract regulatory over-sight. As a result, price lead-ers often engage in subtleforms of diplomacy that usemarket forces to disciplinerenegade companies thatthreaten industry profits.

Preventing a price warwould he easy if it were pos-sible to demonstrate the ben-efits of peace. Sadly, battle-scarred veterans who aresuspicious of one anotherprobably won't unilaterallydisarm. So "price leadership"is one way to reduce indus-trywide price competition.Priee leaders tend to developreputations for eschewingprice cuts as a way to gainmarket share and for re-sponding quickly and deci-sively to price cutting hyrenegade companies. Theprice leaders are viewed as

credible enforcers of price regimes based on theircost structures, strategic postures, or the personalcharacteristics of their officers. We do caution,however, that a pattern of disciplinary moves mayattract unwelcome regulatory scrutiny; companiesshould carefully consider whether their attemptsat exercising leadership may be interpreted as anti-competitive.

Price wars are a fact of life - whether we're talk-ing about the fast-paced world of "knowledge prod-ucts," the marketing of Internet appliances, or thestaid, traditional husiness of aluminum castings. Ifyou are not in battle currently, you probably will befairly soon, so it's never too early to prepare.

If you are currently in a price war, understandthat you can use several nonprice options to defendyourself and recognize that it is sometimes hest tocede the turf under contention and seek greenerpastures. If the current comhatants can't be van-quished, it may be wise to observe the price warfrom the sidelines and enter the fray after everyoneelse has been eviscerated. Sometimes, to the by-standers go the spoils of war.

1. See Carl Shapiro and Hal Varisn, "Veraioning: Tlie Smart Way to SellInformation," HBR November-December 1998.

Repr in t ROO2O8 To order reprints, see the last page of this isBue.

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