React wisely to competitor’s price cuts

Many industries are destroying their capital by indulging in price wars. Online retail, telecom and airline are some of the industries that are on top of my mind. It usually starts with one company and then others make counter moves, thus causing a downward spiral.

Lets say you make chocolates. Your customers love the taste and keep coming back. You are busy with expansion plans which include new stores that offers customers a wholesome experience of aroma and taste. And in the midst of this happy equilibrium a competitor announces a price cut. Suddenly, all hell breaks loose in your company. People from sales and marketing start planning a reaction. What should you do in such a situation?

#1. Analyse cost benefit of your price cut. Cross price elasticity is not symmetric as we saw in the primer on elasticity.

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Every product’s brand and value perception is different. So a price change need not have a symmetric effect. Hence, you need to model the impact of your price change on profitability. If your analysis suggests that you need to announce price cuts, then you should and if you are better off by not reducing prices, then you must stay put.

#2. Setting competitor’s expectation: Some bit of game theory is useful here. If you have a strong brand then you can reduce the price of one fighter brand to send a signal to the competition that you are willing to fight. You could also choose to ignore the price cut to signal that you are not going to indulge in a price war. Your action really depends on the your understanding of the competitive dynamics and your strength in the market place. These dynamics can come out in a workshop that includes key executives.

What is definitely not needed is a knee jerk reaction.

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