The Jedi Path – A Manual for Young Padawans of the Price Wars

A long time ago, in a business Galactic Republic far, far way…

It is a period of economic strife. Droid-manufacturing companies are at each other’s throats to desperately gain a sizeable market share – their weapon of choice being: price.

Suddenly, one brand (Droidtronicss) [1] aggressively slashes prices of its droids to get ahead of the competition. Soon other droid manufactures follow suit, leading up to an all-out price war…

Feel Turbulence in the Industry, One Can

As it happens, in the bid to outdo each other, all droid-manufacturing companies end up being sucked into a death spiral. Ultimately, the industry experiences massive profit erosion.

Let’s try and understand the economics behind this cause & effect situation, using a simple Price Sensitivity Matrix.

In a scenario where reduction in the cost structure is not possible, and the Droidtronics has decided to execute a price reduction, the organization would need to increase the unit sales to maintain the same total gross profits. [2]

If the organization has 30% gross margin, and is considering price reduction of 20%; in order to maintain the same total gross profits, the organization must achieve a 200% increase in unit sales! Compare it with an organization which has 50% gross margin, considering price reduction of 20%. It has to increase the unit sales by 67% to ensure the same total gross profits. [4] Though companies with larger gross margins are able to withstand the price war better, it’s still quite an uphill task to attain such spikes in unit sales. This leaves companies like Droidtronics, and its competitors, fighting a very expensive price war.

The myth that low prices would drive volumes (and thereby profits) gets squashed when the industry turns into a red ocean fashioned out of bleeding contribution margins [5] and commoditized product offerings.

The war also gets customers so habituated to the blitzkrieg of freebies & discounts, that it becomes impossible for brands to stop offering the same. And out goes the second myth that prices can be increased post the price warfare.

Almost all brands end up, floating belly-up in the red ocean they themselves created, while the industry is left gasping for profits.

In this war of prices, there emerges no victor.

As Master Yoda would have put it: “Created is imbalance, in the market forces of the business galaxy.”

Be Mindful of the Jedi (Price) Force

In the universe of strategic pricing, just as in Star Wars, there are two codes: The way of the Jedi (Kantian ethical pricing) [6] and the way of the Sith (predatory pricing) [7].

For the greater good of the industry & customers, organizations need to avoid competing on price, without a fully researched strategy in place. This is the Jedi way of doing business; allowing industries to completely dodge price wars.

“If you define yourself by your power to start price wars, your desire to dominate, to possess, then you have nothing.” (Sic) —Master Jedi, Obi-Wan Kenobi

Yet, sometimes price wars are inevitable. Most can be made of such unavoidable situations, provided the organisations have the ability to accurately read the business context, identify trends and opportunities, and implement structural changes.

Here are a few smart strategies to avoid the price war and in case it has been initiated in the industry, to fight the price war:

1. Strive to create differentiation by leveraging ‘Value’To avoid nasty price wars, it is important to recognise ‘Value’ over price. If a brand is able to prove that it offers value that competition can’t, then it has established a niche for itself and can stay insulated from price wars.This unique proposition for a brand could stem from any element of the brand value chain: quality/sourcing of raw material, the processing equipment and after-sales service to innovations in product and even advertising.Example: Droidtronics, in its desire to become a market leader, slashed prices of its products. With no desire to enter the murky depths of a price war again, Droid “R” Us subsequently launches an innovative droid capable of showing human emotions; thus offering humans a machine capable of being their best friend. Droid “R” Us effectively shifts focus away from price to provide a matchless product that customers would be willing to pay a premium for.

   Needless to say Droid “R” Us emerges victorious in this round.

   The force is strong with this one.

   In the real-life retail scenario, we have the likes of Kmart, Walmart & Tesco; embroiled in price wars for decades now. All three are mass merchandising companies that offer quality products through a portfolio of exclusive brands and labels. The only difference is that the former could not define its value proposition, while the latter two have.

   Walmart projects itself as a welcoming brand & Tesco is about providing fashionable shopping options, apart from being low-cost. Kmart on the other hand pushes out a generic brand story, which doesn’t help it stand out. Hence Kmart has suffered the most, in terms of plummeting sales volumes & store closures – it was even driven to bankruptcy in 2002.

2. Invest in customer & competition researchAccording to Michael Bungert, price wars may start by accident. However, these battles soon end-up being led by emotions, and not logic.Suppose Anikin Moneywalker, Sales Head of Droidtronics, is informed by an industry insider that Droidtronics’ nearest competitor, Droids “R” Us, is cutting prices of their products by 20 per cent. Irked, Anikin retaliates with a 30 per cent price-cut on all Droidtronics product variants for eternity.

• Anikin did this without even being aware of the fact that Droids “R” Us had slashed prices, for just six months & only on the base models, to offload some excess inventory. Droidtronics is haemorrhaging money, as it is now forced to sell its products at low margins for no good reason.
• Anikin also did not realise that customers of Droidtronics appreciated the brand for its premium imagery. By cutting prices, he inadvertently destroyed the brand’s positioning. This encouraged customers to patronize competition.What’s worse, picking up on this aggressive price-retaliation move by Droidtronics, competing brands soon followed suit, not wanting to lose out in this game of short-changing each other. And there you have it, another price war.Unfortunately, the misplaced perception culminated into a price war, where not just Droidtronics, but the entire droid industry experienced dwindling profit margins & tormented customer loyalty.Such a knee-jerk reaction could have been easily avoided had Droidtronics commissioned research into competition’s abilities, motives, mind-set and consumer insights.

  In an ideal case, as soon as there is a tip-off about any competitor price-cut, relevant intelligence must be readily available for decision makers to act quickly and decisively. Such insights can be sourced effectively, if organizations have embedded robust Competitive Intelligence systems to be monitored rigorously at regular intervals.

3. Communicate price drop intent effectivelyIt helps to issue official statements on why a certain price drop has been issued and for how long, so that competition does not perceive it as a price war threat.In the previous scenario, had Droids “R” Us issued a formal statement about why they initiated the price cut, perhaps Droidtronics wouldn’t have misunderstood the move. This could have helped prevent a potential price war.

4. Manage Company Inventory EfficientlyIt is tricky to have excess inventory lying unbilled in company warehouses, especially in periods of financial slump. This not only burdens the organization with inventory carrying costs, but also shrinks the contribution margins by increasing the inherent variable costs hidden in the inventory piled up. The intent then will always be to quickly offload the inventory piled up and recover at least the variable cost. This often results in brands offering steep price cuts, which eventually fuel price wars.Had Droids “R” Us managed their inventory better, they would never have had to cut prices and circumventing any price wars in the industry.The same is true with the Kmart scenario – the brand had a very poor supply chain management that is said to have led to its long spiral down. On the other hand, Walmart mastered its supply chain in innovative ways that included pioneering use of product, consumer behaviour and sales performance tracking technology.

   One guess as to who survived.

5. Seek long-term contracts with key customersIf Droids “R” Us had reached out to a big buyer such as the Galactic Republic’s procurement team, and struck a deal with them to source one million droids in the next 10 years; they would have safeguarded their sales targets for the near future. This way, they can, at leisure, find innovative ways to differentiate themselves from competition on non-price features.Price war successfully eluded.

From all the forced Star Wars metaphors mentioned above, there is definitely a core thought to deliberate upon:

Every time you need to make a pricing decision, ask yourself, will this move trigger a price war? Is it what Darth Vader, or any other Sith Lord, would do? If the answer to any of these questions is yes, then don’t do it. Period.

Follow the way of the Jedi and the Force will be with you, always.

References:

1. Wallace D. (2010). The Jedi Path: A Manual for Students of the Force. Becker&mayer
2. Genenz, K., Lopez-Sors, C., & Alencar, R. (2014). Surviving the Price Wars in Emerging Markets: Three Myths and Three Lessons. Pharmaceutical Executive, 38-42.
3. Michael V. Marn, Eric V. Roegner, and Craig C. Zawada. The Power of Pricing. http://www.mckinsey.com/business-functions/marketing-and-sales/our-insights/the-power-of-pricing accessed on August 30, 2017.
4. Bungert M. (2003). Termination of Price Wars: A Signalling Approach. Deutscher Universitätsverlag.
5. Kainth J. and Mathur A. (2017). Strategic Pricing for Deeper and Enduring Gains. CEOWORLD Magazine, accessed on August 30, 2017.

Note:
1. Fictitious droid manufacturing brand.
2. Gross profit is a company’s total revenue (equivalent to total sales) minus the cost of goods sold.
3. Gross margin is a company’s total sales revenue minus its cost of goods sold (COGS), divided by total sales revenue, expressed as a percentage.
4. Price sensitivity may vary as a factor of the competitiveness in each industry
5. Contribution margin is a product’s price minus all associated variable costs, resulting in the incremental profit earned for each unit sold. The total contribution margin generated by an entity represents the total earnings available to pay for fixed expenses and to generate a profit.
6. http://www.csus.edu/indiv/g/gaskilld/ethics/kantian ethics.htm accessed on August 30, 2017
7. http://www.thestarwarsrp.com/forum/index.php?threads/sith-beliefs-philosophy.60168/ accessed on August 30, 2017

Written by: Jyoti Kainth, Institute of Management Technology Ghaziabad, India and Pooja Pillai, Curiouser & Curiouser, India.

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