Rule 5: Price wars are a fool's game
Rule #5 of our recently published ChangeThis manifesto...
On April 9, 1992, American Airlines—hoping to stem the decline in air traffic that US carriers had been experiencing since before the first Gulf War—introduced a simplified pricing structure called “Value Pricing.” While the intent was to simplify fares—internal findings had determined that more and more passengers were being turned off by the growing complexity of airline pricing models—to its competitors, the move was interpreted as the first shot in a new pricing war.
A month and half later, Northwest Airlines retaliated by introducing a promotion called “Grown-Ups With Kids Fly Free.” It only took American Airlines a day to counterattack: prices were slashed 50% on every seat of every airplane that American flew. Within 24 hours, every major US airline matched American’s price cuts. The war was on!
The events in May were unprecedented and the effects impressive. According to industry observers, it was “an electronic passenger riot—the telecommunications equivalent of shoppers tearing through goods in a sales bin.” AT&T was said to have been overwhelmed with long-distance phone volume the days after as consumers jumped at the chance to take advantage of the lower fares.
Some were so determined to purchase tickets that when they couldn’t get through by phone, they got in their cars and drove to the airport to buy tickets before the sale ended.
Paying passengers made out like bandits, but the airlines experienced different results. Despite record capacity over the next three months, record losses followed—some estimates pegged airline industry losses over that same three-month period at $1.5 billion.
This was just one of many price wars that the airlines self-inflicted on each other over a 20 year period that began in the 1980s and just recently ended. The death toll over that time period is noteworthy. Hundred of airlines declared bankruptcy, tens of thousands of employees were laid off or fired and losses exceeded $15 billion–erasing every dollar in profit that had been made by the airline industry from its inception. 1
So what’s the best strategy to survive price wars?
First of all, don’t initiate them. The only way you can cut prices enough to increase market share and profits is if your competition is either (a) asleep at the wheel or (b) unable to follow suit.
With today’s competitive environment, neither response is realistic. In most every case, cutting price to gain market share will be unsuccessful because competitors will match your price— and sometimes they’ll even undercut your price.
Just as important, prepare in advance to defend against any type of price war directed at you. Do everything possible to compete on dimensions other than price. Whether it be differentiated quality, customer service or the myriad intangibles that may separate you from the competition, you need to un-commoditize your offerings. Additionally, work hard to instill in your client base the perception that value indeed, does follows price.
Here's the takeaway: Don’t kid yourself—price wars are a fool’s game.
1 David Besanko, “The Mother of All (Pricing) Battles,” Kellogg School of Management, Northwestern University, 2004.