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Price war is "commercial competition characterized by the repeated cutting of prices below those of competitors".[1] One competitor will lower its price, then others will lower their prices to match.[2] If one of them reduces their price again, a new round of reductions starts. In the short term, price wars are good for buyers, who can take advantage of lower prices. Often they are not good for the companies involved because the lower prices reduce profit margins and can threaten their survival.

In the medium to long term, price wars can be good for the dominant firms in the industry. Typically, the smaller, more marginal firms cannot compete and must close. The remaining firms absorb the market share of those that have closed. The real losers, then, are the marginal firms and their investors. In the long term, the consumer may lose too. With fewer firms in the industry, prices tend to increase, sometimes higher than before the price war started.

Causes

The main reasons that price wars occur are:

Reactions to price challenges

The first reaction to a price reduction should always be to consider carefully. Has the competitor decided upon a long-term price reduction? Is this just a short-term promotion? If it is the latter, then the reaction should be that relating to short-term promotional activity, and the optimum response is often simply to ignore the challenge. Too often, price wars have been started because simple promotional activities have been misunderstood as major strategic changes.[citation needed]

But if it seems that it is a long-term move then there are many possible reactions:

Avoiding price wars

Avoidance is by far the best policy, but it is advice which may not always be taken if the benefits seem attractive to others (which they may also be to competitors).[citation needed]

Price stickiness

In oligopoly markets prices can become 'sticky' because if the price rises, competitors will not follow the rise. So the merchant will lose its market share to its competitors on lower prices. But if the price falls, other players will merchants will follow suit if they can. At some point, merchants find that they can not gain profit if they cut the price further— so the sticky price remains.

Price stickiness is extremely common among large supermarket chains and prices, especially for commodities, tend not to vary much between them. Many of the supermarkets monitor price changes in other supermarket chains and vary their prices accordingly until they reach the point where any further decrease in their price will affect profits.

See also

References

  1. ^ "Definition of "Price war"". Merriam-Webster.
  2. ^ "How to Fight a Price War". Harvard Business Review.