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Price Wars 2.0: A New Era of Price Wars

Posted by PriceBeam on September 8, 2017

price wars

Traditionally, price wars looked different than those we see today. For one, they were deliberately started as a strategic move to take away market share from competitors, force out new entrants with predatory pricing, or restrict entry for fledgling firms looking to get a share of the market. Roughly speaking, the price war was ‘won’ by the firm with the most cost-efficient operations, i.e. the firm that could set the lowest price without pushing prices below their variable cost.

Today, price wars take different shapes for two reasons: 1) Firms are using advanced price setting algorithms and competitor monitoring, which means that price wars are often fought by machines, and not people. 2) The outcome of the price war is determined by capital backing, and not operational efficiency.

 

The Machine-Fought Price War

Machines are yet incapable of making strategic decisions as were they people. They can make all sorts of quantitative analyses, factoring in hundreds of different variables, but they are still unable to qualitatively assess many situations. So when a human sets a new, lower price for Company A, with a strategic motive or a motive that is based on a qualitative assessment of a business situation, Company B’s pricing algorithm may see this as its cue to start undercutting Company A’s price. As this undercutting prevents Company A from pursuing its intended strategy, Company A will have to engage in a price war to keep pursuing it.

Or worse: both Company A and Company B’s prices are set by pricing algorithms, which for some reason decide to keep undercutting each other, then it can literally be a matter of hours before the market has lost millions in profit. The speed of price changes today makes it so: because in the market, there is not just Company A and Company B, but also Company X, Y and Z, who will follow suit – or their pricing algorithms will, that is.
With the sophisticated competitor monitoring that is employed by firms, price setting is very interconnected. Tesco reduces the price of beef because they are trying to promote their new ‘burger-building kit’, which makes Sainsbury’s reduce the price of beef and pork (pork being a substitute for beef), and from there it accelerates out of proportions.

One example of automation accelerating things out of proportions was the ‘Crash of 2:45’ in 2010, where trading bots led to a massive decline in stock prices (lasting only 36 minutes before stock prices were back up) – 36 minutes was all it took to wipe out more than $1 trillion from the US stock market. All because of automated trading.

 

The Capital-Backed Price Warrior

Back in the days, the race to the bottom concluded when prices reached variable cost. However, Silicon Valley has fundamentally changed this race. Some of the most valuable tech-firms, Uber and Spotify for example, are still losing money, yet their valuations keep going up. Investors value market share more than anything in their pursuit to create a monopoly for themselves, and cash in on their investment in a very distant future. Peter Thiel, one of the leading tech-investors in Silicon Valley, puts it like this: “In tech, it’s not about being the first mover. It’s about being the last.” According to Thiel, “competition is for losers” and his ultimate goal is for his investments to reach a monopoly position, where no one would dare to enter this market ever again. Google is one such example: no one would dare to build a new search engine today, as they simply wouldn’t stand a chance. It took Google several years with increasing market share as its sole objective until it reached its dominant position, and in 2016 it produced an operating profit of almost $10bn.

Investors allow their investments to lose money, in fact they encourage it, in their pursuit of a monopoly position. It pushes the lower bound even further down, and all rules for business sustainable are set aside. Investors bet on the business model, not hard proof of sustainable cash flows in the short term.

 

Fighting Price Wars is More Dangerous than Ever

Consequently, price wars are now tougher than ever, and the outcome is unpredictable as it’s not based on operational excellence, but on investor faith. You cannot predict if you will come out on top based on your business performance, which makes it an incredibly dangerous game to play. Losing a price war is detrimental to any company, but now more than ever. The key lesson is that competitor-based pricing should be kept to a minimum, and competitors’ prices should merely be used to understand your business’ context, rather than as a pricing guideline.

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Written by PriceBeam

PriceBeam
PriceBeam posts regular guides, articles and news related to pricing and strategy. Go have a look!