As with any decision in life, one has to consider not only the alternatives evaluated, but also the option of simply backing down and doing nothing for the time being. The decision of whether or not to respond to a competitive threat is no exception. Aaron Rodriguez, a business management and sales expert, provides the necessary information for an SME to know how to respond to a price war initiated by a competitor in the same market.
When the competition cuts prices or is launching a new product at low prices, we must begin to consider whether there is a less costly response than the expected loss in sales. To do this, calculate the cost of the “do nothing” option, which corresponds to the gross contribution of sales that would be at risk.
“The ideal response would be to lower the price only for highly price-sensitive customers, without lowering the price for less price-sensitive customers who have a low probability of stopping returning. This can be achieved by launching a Flanker or combat brand, by launching basic versions of the product or service we are selling, or by using any of the other segmentation tactics. If the answer to the above question is yes, we must ask ourselves why the competition decided to compete with low prices and how much it has to lose if it enters a price war. This will help us determine the probability that, if we lower our prices, the competition will lower theirs again,” Rodriguez explains.
If you think this probability is low, it would be appropriate to respond in the most segmented way possible. But if, on the other hand, you think there is a high probability that the competition will cut its prices again, you have to ask yourself whether these multiple responses still cost less than the expected loss in sales if you don’t respond. To do this, one has to consider the total cost of the possible price war, taking into account that once the competitor gains sales, it will have more to lose.
“If we believe that multiple responses cost less than giving up threatened sales, it would be correct to respond,” Rodriguez points out. “If, on the other hand, we believe that the cost of not responding is lower, we should analyze how much our position in other markets is at risk if the competitor gains sales. If the threatened products are complementary to other products, then losing sales in a threatened line would also mean losing sales in other related lines.”
If you believe this will not happen, you accept this new reality and assume the expected loss in sales. But if you believe that other lines of business are at risk because of the primary threat, you must ask whether the value of the markets at risk justifies the cost of the response. To do this, it is also important to determine how important the threatened markets are and what the long-term value of retaining those markets is.
Rodriguez says, “At the end of the day, if we conclude that the value of all markets related to the originally threatened market is worth no more than the expected loss in sales, then we accept or ignore the situation. If, on the other hand, we believe that the cost of not responding is greater than the value of the markets at risk, we should respond.”
In summary, the response to the threat of a competitor cutting its prices depends on two elements. On the one hand, whether the competitor is strategically stronger or weaker than your business and, on the other hand, whether or not the price cut is financially justified.
If the competitor is strategically weaker than you and the price cut is not financially justified, you should ignore the situation and not lower prices, as there will probably not be a big impact on your business’ sales.
When the competitor is strategically equal or stronger than you, it means that this threat will surely affect your position in some of the segments you currently serve. In this case, you must accept this new reality, not by lowering prices, but by accommodating and focusing our strategy on other market segments.
If the competitor is strategically equal or stronger than you, but the price cut IS financially justified, it is of utmost importance to defend yourself in a segmented way that we will see in the next module.
Finally, if the competitor is strategically weaker than you and the price cut is financially justified, it is because you are probably facing an opportunity to serve a market segment that you may not have identified before.