Price Wars Upper 6 th Micro Pricing Strategies

Price Wars Upper 6 th Micro Pricing Strategies

Intro to Price Wars Mr O’Grady

Price wars Definition: competition in prices characterised by the repeated cutting of prices below those of competitors One competitor will lower its price to undercut its rivals and boost short term profit. Others will then lower their prices to match If one firm reduces their price again, possibly in retaliation, a new round of reductions starts All firms make less SNP in the short run as they receive lower prices (as per KDC result) Conditions: Price wars generally take place in oligopolies where firms are making only slightly differentiated versions of the same product As a firm’s product is a close substitute to its rivals, cutting can quickly increase market share as consumers would mostly choose the cheapest product If a firm expects that a price war will boost its long run profits from a growth in market share, more so than it harms its short run profits, then a price war can be a rational strategy This is most likely if the aggressor firm believes it can sustain its first mover advantage in market share and/or that its rivals will not survive the war But this can be a very risky strategy as there is no guarantee of greater future profit

Impacts of Price Wars Mr O’Grady

Impacts of Price wars Impacts on Firms: Price wars are nearly always bad news for most businesses that get into them. Deep discounts on prices doesn’t necessarily increase revenues. PED will be likely be inelastic as the mutual price cutting of rivals will mean few extra sales Price cutting erodes profit margins and can lead to firms making losses and shutting down However: This could be of benefit to survivors of the war Lower profits mean fewer resources are available to fund capital investment. Reduced Dynamic efficiency Impacts on Consumers: Quality may be adversely impacted as firms seek to cut costs Prices fall for consumers, an increase in consumer surplus Price wars on essential products can have a bigger relative impact on low-income families (progressive) However: Should the price war lead to the death of some firms, the survivors might have more market power in future and set higher prices than before the war, to recoup lost profits There might also be lower choice as there are fewer firms Impacts on Suppliers: Firms at war aim to cut costs to sustain their price cuts, so may look to pay suppliers less This can be particularly bad if the firm has significant monopsony power

Examples of Price Wars Mr O’Grady

Examples of Price wars UK Supermarkets: The big four UK supermarkets (Tesco, Sainsburys, Asda, Morrisons) have routinely got into price wars This has stepped up as well with the growth of discount supermarket chains Aldi and Lidl in recent years They regularly cut prices on goods such a milk, bread, cereal and petrol Despite this, none of the big four firms have seen any significant growth in their market share However: the wars have had significant impacts on the supermarkets’ suppliers, with many food producers being forced out of business (146 in 2014) US Pizza Chains: Pizza Hut, Little Caesar’s and other firms engaged in a price war via heavy couponing and deals such as 2 -for-1 This led to market share gains for the largest firms, but loses for the smaller ones’ Quality of Pizzas was noticed to suffer A long-term impact was that consumers got used to low prices, and as a result, they became unwilling to pay higher prices later, limiting the payoff for the survivors despite ‘winning the war’ “Only the dead have seen the end of war. ” - Plato

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