Transcript to win price war

Lecture 13 Competition and Pricing
Motivation questions
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What motivate a company to cut price?
Why is a price war harmful?
1999, Sprint announced 5 cents nighttime long-distance rate
MCI matched
ATT offered 7 cents all day
Sprint was forced to drop price further
ATT’s stock price dropped 4.7% the day of announcement.
MCI stock price dropped 2.5%
Sprint stock price fell 3.8%
What could have ATT done in 1999 to prevent Sprint from cutting
price?
If Sprint has already cut the price, what could have been done by
ATT to win the war?
Classifications of Competitive Behavior
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Cooperative pricing
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Adaptive pricing
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use price to gain market share
Predatory pricing
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small firms take prices set by large firm
Opportunistic pricing
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monopolistic competition
recognize a common interest
a firm use low price attempting to punish another firm or drive
it out of business
Limit pricing
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Discourage the entry of potential competitors
Understanding Pricing Game
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Incentives for undercutting price
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Evil intention
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extra market share and opportunistic profit if not immediately
retaliated by competitors
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Good intentions
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A firm strategically changes the way business is done
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especially true for industries with high fixed cost and peak seasons
Office Depot
A firm offers additional feature without increasing price
A firm misreads the change in market share
A firm overreacts to a competitor’s limited and focused price reduction
with an across-the-board price reduction
If you cut price for good intentions, make sure your competitors do
not misinterpret your intentions
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Price war is “negative-sum” game
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Economic disaster
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Difficult to increase profits by reducing price
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No gain if immediately retaliated by competitors
Cutting price rarely drives competitors out of business
Psychological trauma
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Coca-Cola, 1% reduction means $20million reduction in operating profit
Lower consumer reference price
Reduce consumer sensitivity to quality
Train loyal consumers to switchers
Depending on how competitors interpret your move, your price cut
that boost sales today will radically change the industry you
compete tomorrow! That change is forever.
“Negative-sum game” Illustrated
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Prisoner’s dilemma
Prisoner A
Confess
Confess
Prisoner B
Does not confess
Does not confess
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Winning “negative-sum” battles requires
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management forward-looks future behavior of competitors
and consumers and resulting profitability.
a process of 3 steps:
 Step 1: make long-term plans (to prepare for future price
war)
 Step 2: diplomatically communicate with your
competitors (to avoid price war)
 Step 3: wisely choose confrontation (to win price war)
How to Fight the Price War?
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Step 1: develop long-term plans to prepare for price war
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Setup market intelligence to understand competitors
 Information on competitors
 What: price structure, transaction price, history of price
moves, cost, capacity
 How: sales force, favored consumers, trade associations,
list future prices, ghost shop, distributors, technical
consultants, securities analysts
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Information on demand
 What: future growth of the market
Develop price leadership
 Will be discussed in Federated Industries
Build up sustainable competitive advantages
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Step 2: legally “communicate” with your competitors to
avoid price war
 Reveal that your intention of price cut is temporary and not
threatening
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Reveal your capability of fighting a price war
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excess inventory
over capacity
future growth of the market
introduction of a simple version of the existing product
cost advantage
future expansion plan
willingness to fight back
Winn-Dixie, Big Star and Food Lion
Pre-announce price increases
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American Airline
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Tools for competitive signaling
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Match price cut immediately
A discount mimic exactly your competitor’s offer
Test the water (American Airline)
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Announce new, patented manufacturing process
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Announce intentions, capabilities and future plans
Show willingness and ability to defend
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Japanese manufacturer
1990s Chrysler minivan
Publicize a competitor’s opportunism
Legal suit
Price structures carry signaling messages
 Bundled price
 Two-part price that reward additional business
 End-of-year rebates rather than quantity discount
 Functional discounts
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Step 3: wisely choose confrontation (to win price war)
Non-price actions
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Focus on the other 3 Ps.
1997 Malaysian Ritz-Carlton
Alert customers to risk poor quality
Fedex “absolutely and positively be there”
Price-related actions
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Change consumer choice
1980, McDonald “value meal”
Cut price selectively
Sun Country Airlines
Develop a fighting brand
1990, Kao Corporation and 3M
Offer new package and lock in future sales
“buy one, get one free”
Match the price cut
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Match price cut but protect profit
HP, IBM, “fee PCS”
Do it quickly to avoid future cut
Retreat
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It may be wise to cede market share
1980s, Intel dropped DRAM, Taiwan
1990s, 3M withdrew from videotape
General principle, response should be focused and in kind (titfor-tat). When competitors move back to rational price, show
immediate support.
When is it profitable to initiate a price cut?
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Aggressive (opportunistic) pricing is profitable when
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incremental cost advantage
 Wal-Market, Southwest, Dell
products attractive to a small share of market
 ATT vs. Sprint
will not catch immediate attention
 Federated Industries
related products can be cross-sold in the future
 Microsoft
demand is still growing at the product growth stage
have excess capacity (keep excess capacity)
Key: justify your price cut to avoid price war
Take-aways from today’s lecture
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Price war is a “negative-sum” game. In the long-run,
it hurts every players in the industry.
Winning price war requires
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Step 1: develop long-term plans (to prepare for future price
war)
Step 2: diplomatically communicate with your competitors
(to avoid price war)
Step 3: wisely choose confrontation (to win price war)
Decision on initiating or matching price cut should be
made based on long-term consequence
Next Lecture
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Product Lifecycle pricing