Price wars generally occur in oligopolistic markets and are characterized by repeated cuts in prices below competitors' prices. While this can boost short-term profits through increased market share, it erodes profit margins and can lead firms to make losses or shut down. Price wars impact firms through reduced profits and investment, consumers through both lower prices and potentially reduced quality, and suppliers who may face pressure to accept lower prices. Examples include the UK supermarket industry and US pizza chains, where repeated price cuts had mixed effects on market share and long-term consumer prices.
3. Price wars
Definition: competition in prices characterised by the repeated cutting of prices
below those of competitors
One competitor will lower its price to undercut its rivals and boost short term profit.
Others will then lower their prices to match
If one firm reduces their price again, possibly in retaliation, a new round of reductions starts
All firms make less SNP in the short run as they receive lower prices (as per KDC result)
Conditions: Price wars generally take place in oligopolies where firms are making
only slightly differentiated versions of the same product
As a firm’s product is a close substitute to its rivals, cutting can quickly increase market share
as consumers would mostly choose the cheapest product
If a firm expects that a price war will boost its long run profits from a growth in market share,
more so than it harms its short run profits, then a price war can be a rational strategy
This is most likely if the aggressor firm believes it can sustain its first mover advantage in
market share and/or that its rivals will not survive the war
But this can be a very risky strategy as there is no guarantee of greater future profit
5. Impacts of Price wars
Impacts on Firms:
Price wars are nearly always bad news for most businesses that get into them.
Deep discounts on prices doesn’t necessarily increase revenues.
PED will be likely be inelastic as the mutual price cutting of rivals will mean few extra sales
Price cutting erodes profit margins and can lead to firms making losses and shutting down
However: This could be of benefit to survivors of the war
Lower profits mean fewer resources are available to fund capital investment.
Reduced Dynamic efficiency
Impacts on Consumers:
Quality may be adversely impacted as firms seek to cut costs
Prices fall for consumers, an increase in consumer surplus
Price wars on essential products can have a bigger relative impact on low-income families (progressive)
However: Should the price war lead to the death of some firms, the survivors might have
more market power in future and set higher prices than before the war, to recoup lost profits
There might also be lower choice as there are fewer firms
Impacts on Suppliers:
Firms at war aim to cut costs to sustain their price cuts, so may look to pay suppliers less
This can be particularly bad if the firm has significant monopsony power
7. Examples of Price wars
UK Supermarkets: The big four UK supermarkets (Tesco, Sainsburys, Asda,
Morrisons) have routinely got into price wars
This has stepped up as well with the growth of discount supermarket chains Aldi and Lidl in
recent years
They regularly cut prices on goods such a milk, bread, cereal and petrol
Despite this, none of the big four firms have seen any significant growth in their market share
However: the wars have had significant impacts on the supermarkets’ suppliers, with many
food producers being forced out of business (146 in 2014)
US Pizza Chains: Pizza Hut, Little Caesar’s and other firms engaged in a price war
via heavy couponing and deals such as 2-for-1
This led to market share gains for the largest firms, but loses for the smaller ones’
Quality of Pizzas was noticed to suffer
A long-term impact was that consumers got used to low prices, and as a result, they became
unwilling to pay higher prices later, limiting the payoff for the survivors despite ‘winning the
war’
“Only the dead have seen the end of war.” - Plato
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