What happens during a price war and how to manage through it

Supply chain restrictions and inflation have been the big topics in 2022. In 2023, the tides are changing. Higher interest rates are triggering declines in demand while supply chains have recovered. Over-capacities are becoming more frequent again and companies are reflecting if they might have overdone it with their price increases in 2022. Is it now a good time to cut back on prices and finally win some market share?

This is a good question and there is not an easy answer to it. However, there is one certainty. You probably want to stay out of a price war.

“Lowering prices is easy. Being able to afford to lower prices is hard.” — Jeff Bezos

What are price wars?

Price wars can be aptly defined as a game of high-stakes chicken. An aggressor, desiring more market share, reduces prices (often significantly) to drive demand. Competitors, unwilling to concede market share, then lower their prices to mitigate the potential loss of market share. Both companies are now sacrificing short-term profitability with the goal of forcing the other to reach its breaking point, where it cannot afford to lower prices further without risking the long-term viability of the company.

What industry is currently in danger of entering a price war?

We are currently witnesses the early stages of a price war play out in the electric vehicle (EV) market with Tesla serving as the aggressor.

Tesla, relying on its industry leading margins and superior profitability, believes it can effectively weaponize price cuts and get through the ensuing price war with rival EV companies unscathed.

The same Tesla, which for years forsook profitability in the name of growth, now commands a significant lead over rivals in profit per vehicle. According to Reuters analysis, Tesla earned $15,563 in gross profit per vehicle in the third quarter of 2022 – double Volkswagen, quadruple Toyota and five times Ford.

Elon Musk, never one to shy away from being aggressive, smelled the blood in the water and believed it was time to act. And in January of this year, Tesla came out aggressive – slashing prices on almost all models up to 20%

For the first mover, in this case Tesla, the early results often appear to support the decisions. For example, the Model Y jumped from 70th to 2nd in searches on the car-shopping website Edmunds. And the Model 3 jumped from 37th to 11th.

However, the long-term results are often much bleaker as observed by Simon-Kucher’s three-plus decades of advisory experience in pricing, sales, and marketing.

While this price war is still playing out, we believe several of the following consequences will emerge in the coming months:

1. Tesla’s reputation as a premium brand is at risk of getting tarnished

Premium brands do not need to lower prices because they have already established a valid price-value relationship. By cutting prices, Tesla is signaling that they were overpriced. This can be greatly aggravating to recent customers, who feel duped and that they overpaid, as well as less recent customers, who have seen the re-sale value of their vehicle depreciate significantly overnight. Additionally, the number of EV options for consumers will continue to grow as established brands and new players enter the market. Legacy premium brands, such as Audi and Porshe, are already beginning to make inroads.

2. Some competitors will follow suit resulting in a prolonged price war (the lose-lose prisoner dilemma outcome)

Ford has already responded with a $5,900 price cut of the Mustang Mach-E. To further differentiate its models from the Mustang Mach-E, Tesla now has a more limited playbook. Quickly re-raising prices would signal defeat while further cutting prices would continue to weaken margins. Instigating a price war is easy, exiting one becomes much more difficult.

3. Some competitors will not engage in the price war

GM, meanwhile, has indicated that they do not plan to engage in this price war. GM’s leadership team believes in their pricing strategy and long-term visions. They are willing to sacrifice short-term market share to maintain per vehicle profitability. The Executives at GM are likely wanting to avoid a similar price cut mistake made in 2005. Significant price cuts spurred short-term demand but had severe long-term consequences as demand was merely pulled forward, rather than being net new.

How to manage through price wars?

Price wars can be damaging to businesses in the long run, as they can lead to reduced profit margins and damage to brand reputation. At Simon-Kucher, we firmly believe that avoiding price wars are paramount to a business’ health.

However, if you find yourself in the early stages of a price war, here are a few strategies that your businesses can use to avoid getting into a price war:

1. Focus on differentiation: Rather than competing on price alone, focus on the value drivers that make your product or service unique. This could be anything from superior quality to outstanding customer service. Highlighting these features can help customers see the value in your product, and they may be willing to pay a higher price for it.
2. Offer additional value: Instead of discounting your prices, offer additional value to your customers. This could be in the form of value-added services, a loyalty or rebate program, or a bundled package that includes several products or services. By providing more value, customers may be more willing to pay a higher price.
3. Enhance value articulation: Train your sellers to focus the conversation on value rather than price. Value articulation focuses on how your product or service will provide value to the customer instead of focusing on price. Seller must also be able to handle price objections. Handling objections well can mean the difference between achieving the target price increase, capitulating to discount demands, or losing a customer.
4. Watch your competitors: Keep an eye on your competitors and the market to ensure you are not pricing yourself out of the market. If you notice that your competitors are lowering their prices, assess and quantify the impacts of pricing decisions on volume, profit, and brand image before answering with price decreases and potentially initiating another price war round.
5. Concede surgically: Before reducing price, consider non-price concessions that are valuable to your customer. If all else fails, be sure to drop prices strategically and surgically. Price cuts for specific products, in specific regions, for specific customers is always advised over broad across-the-board reductions.

By following these strategies, businesses can manage through price wars and focus on creating long-term value for their customers.

Please feel free to contact the authors for further information on this topic. We look forward to engaging with your growth challenges and we can be reached at [email protected] and [email protected]

ABOUT THE AUTHORS:

Peter Harms is a Partner with Simon-Kucher in Boston.

His consulting focus is on pricing, sales, and negotiation management in the automotive industry.

Peter helps his clients to better understand, quantify, and communicate their customer benefits. He also improves his clients’ capabilities to increase and monetize their customers’ willingness to pay.

He has conducted consulting projects for companies in Europe, North America, and Asia. Among his clients are automotive suppliers, automotive manufacturers, as well as machinery and heavy equipment manufacturers.

In addition to his consulting work, Peter is a speaker, coach, and trainer in the areas of power pricing, sales excellence, and negotiation excellence. Peter studied business engineering at the University of Karlsruhe (TH), Germany, and has been with Simon-Kucher since 2001.

Tom McClure is a Senior Manager with Simon-Kucher in Houston.

His consulting focus is commercial excellence and business transformation in B2B industries. He has worked with management teams to drive sustainable revenue growth and margin expansion for clients by developing tailored growth strategies adapted to their needs, challenges, and opportunities.

Prior to joining Simon-Kucher, Tom held roles as a as a business transformation design & execution consultant with EY, and as a project startup & commissioning manager and project development & design engineer with ExxonMobil.

Tom received a Bachelor of Science in Chemical and Biomolecular Engineering from the Georgia Institute of Technology.