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Five rules to win a price war – at least in the short term

Five rules to win a price war – at least in the short term

With Amazon set to enter the Australian market later this year, many of Australia’s leading retailers are gearing up for the fight of their lives. We think they would do well to take note of recent analysis by MIT Sloan School of Management, which identifies five rules for management to follow to maximise their chances of success.

Some market commentators are speculating (with an unusually high level of assumed confidence) that the arrival of Amazon may lead to price wars within particular industries. Our team, however, would be the first to admit (with a degree of humility) that we can’t be sure exactly what the outcome may be. The future is, after all, largely unpredictable.

Even without complete knowledge of the future, however, we can already think about some core concepts when it comes to the impact of aggressive competition.

Price wars are interesting because, in a sense, they’re an acceleration of the impact of competition forces which would otherwise be more slow-acting. Hence, in considering why a company may enter a price war, it’s clearly because it believes that its economics/strategy is superior to that of its competitor and, thus, will win some kind of outcome longer term which is expected to be greater than the short-term cost of the price war.

Frequently, however, this is not the case, and such aggressive competition simply ends up destroying value for shareholders.

MIT Sloan did an analysis with respect to the Dutch supermarket Albert Heijn of a particular price war which it won, and went on to prosper for some time. From this, MIT identified 5 rules for management teams to follow in order to maximise their chances of success.

  1. Affirm the need (be prepared).
  2. Pick the battlefield (minimise pain to your own profit centres and maximise pain to the competitors).
  3. Pick the target (it’s easier to compete against one smaller competitor than several large ones).
  4. Stay under the radar (in order to minimise the response to your competitive act).
  5. Align revenues with cost structures and rally the support needed to succeed (to minimise the collateral damage to your own profit margins that competitive acts such as discounting entails).

If you think about it, all these rules are fairly rational – the idea being that a competitive act should maximise the damage to competitors whilst minimising the damage to the aggressor at all levels (the group level, product levels and business relationship levels).

Unfortunately for the victors of price wars, the victory can be short lived. Rivals burned by competitive acts can respond in future, having learned from the mistakes of the past, eroding profitability not only for themselves and the target but the industry in general.

This is perhaps not surprising – the profitability of all firms in a state of competition over the very long term will always deteriorate to mediocre levels. I guess, in a way, the law of gravity holds even in economics.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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