Price war

The repeated cutting of prices is highlighted in the Merriam-Webster Dictionary definition of a price war. ==Causes==

The main reasons that price wars occur are: • Homogenous products: Where products are homogenous, and product substitution between firms is high, then the price elasticity of demand will also be high. As a result, if one company in an industry lowers its prices, other firms offering similar products must also reduce their prices to retain their market share. • Penetration pricing: If a firm is trying to enter an established market, it may offer lower prices than existing brands to incentivise consumers to switch to their product. • Oligopoly: If the industry structure is oligopolistic (that is, has few major competitors), the players will closely monitor each other's prices and be prepared to respond to any price cuts. :*Applying game theory, two oligopolistic firms that engage in a price war will often find themselves in a kind of prisoner’s dilemma. Indeed, if Firm A reduces its prices whilst competitor, Firm B, doesn’t reduce its prices, then Firm A can capture market share. And, if Firm A reduces its prices, then Firm B must reduce its prices to avoid being eliminated from the market. The equilibrium is such that both firms adopt a low-price strategy to protect themselves. Predatory pricing on the international market is called dumping. That is, when a foreign company sells a product in a domestic market at a price below market value, and in doing so, causes injury to the industry in the domestic market. ==Reactions to price challenges==

The first reaction to a price reduction should always be to consider the following: Has the competitor decided upon a long-term price reduction or is this just a short-term promotion? If the competitor has implemented a short-term promotion, the ideal response is to monitor the competitor's price changes and maintain prices at the current level. Price wars often begin when simple promotional activities are misunderstood as major strategic changes. If the competitor is implementing a long-term price change, the following reactions may be suitable: • Reduce price: The most obvious, and most popular reaction is to match the competitor's move. This maintains the status quo (but reduces profits pro rata). • Maintain price: Another reaction is to hope that the competitor has made a mistake, but if the competitor's action does make inroads into a merchant's share, this can soon mean customers lose confidence and a subsequent loss of sales. • Split the market: Branch one product into two, selling one as premium and the other as basic. This effective tactic was notably used by Heublein, the former owner of the Smirnoff brand of vodka. • React with other measures - Reducing price is not the only weapon. Other tactics can be used to great effect: improved quality, increased promotion (perhaps to improve the idea of quality). ==Effects==

Empirical studies suggest that price wars can significantly damage the companies that practice such behaviour. ==Examples==

Price wars are prevalent in many industries, telecommunications, automotive, and airlines. Some key examples include: • 1992 United States airline price wars: American Airlines, Northwest Airlines, and other United States carriers matched and exceeded the reduced prices of one another, resulting in increased sales volume but record losses. Revenue from oil exports is heavily relied on by many governments, with Iraq, Kuwait, and the Republic of the Congo reporting oil rents (as a percentage of GDP) over 30%. Lower market prices led to reduced profit margins and put financial pressure on such governments. ==See also==