We have all experienced this. Sales that previously looked great start to decrease month after month. Is it because of lower customer demand? Or is it due to issues with distributors? Perhaps there is something about the competitors’ landscape we did not notice? Seeing a new competitor enter your market is never a great experience, but realizing they offer similar products and services at a shockingly-low price is especially scary. But what should a company do after the initial panic?
I’ve been there; it is not fun. But you can’t sit there and do nothing. The first step should be conducting a proper evaluation of the situation. Seeing competitors offer much lower prices for an extended period of time can mean two things: 1 – an existing competitor is starting a price war, or 2 – a new competitor is entering the market with a low-cost model. These two scenarios might look similar, and the consequences can be nasty, but there are some significant differences.
The two scenarios of lower prices
A price war involves existing competitors deciding to significantly lower their prices in order to gain market share. These competitors might have similar profit margins and business models as your company, and their move most likely drives the industry’s profitability down. They might have a plan (launching new products and trying to get rid of their inventory of old products faster, etc.), but at a product level, these price changes will kill profitability until it is no longer sustainable. Other companies in the industry might lower their prices in response, which can spiral out of control and cause companies to go broke. A price war can be a disaster for everyone involved if no rival has a way to significantly cut costs and maintain healthy profit margins.
The other scenario is a new competitor entering the market with a low-cost business model (see my previous article on these companies https://fmaingret.com/2022/02/the-difference-between-penny-pinching-and-true-low-cost-strategies/). These companies will find ways of offering similar products and services at a much lower price than the competitors while still being profitable. They will typically have a different value proposition and very efficient operations. For example, Aldi only offers a limited number of items in their stores, has simple store layouts (they display their products on pallets to save time), and uses smaller, cheaper locations for their stores in order to offer very competitive prices on groceries. It is not a price war since they entered the market with set prices and have not necessarily gradually lowered them over time.
Years ago, traditional US-based airlines, like United or American Airlines, engaged in a price war. They continuously offered better pricing to travelers to gain market share. Then, Southwest entered the market and offered rates that the two others could not match.
How will lower prices affect your business?
Once you clearly understand what is going on and what the threat is, you should wonder how bad this situation could be. While it might seem scary, some companies won’t be affected at all by these low-cost companies entering the market, while others will be in big trouble.
Will your customers stop buying from you and go to these competitors instead? If you are a massive grocery store chain like Walmart or Kroger, a new chain of groceries stores like Aldi could impact your business. Now, if you are Louis Vuitton, you probably aren’t worried about a new company selling $10 purses stealing your loyal customers. If you know you won’t lose customers, keep an eye on them but don’t worry too much. If the new competitor can impact your business negatively, you need a solid plan.
What to do when competitor lower their prices?
The first strategy is to avoid competing on price, but to differentiate your offer from the low-cost rival; the idea is to come up with an offer that doesn’t only rely on pricing to gain market share. There are many ways for a company to differentiate itself, such as building a “cool” brand like Redbull or Apple, a unique shopping experience like Trader Joe, or innovative products like Unilever. It is easier said than done and has several challenges. Companies opting for this approach should ensure the customers are willing to pay a premium for these extra benefits. Starbucks can charge a few more bucks for a cup of coffee, but not every business selling coffee can charge these prices. And while innovation can bring new customers in, it is costly and can be copied by competitors. However, this can be highly profitable and will allow the company to avoid competing directly with low-cost competitors.
The alternative is, of course, to compete on price. In that case, a company can either turn itself into a low-cost business or create a separate entity. But, this is very difficult to pull off: switching to a low-cost strategy requires a company to completely rearrange its business, processes, organization, resources, etc. Moreover, switching to a low-cost offer drastically affects the brand image. This can allow the company to gain more customers as the prices get lower, but it can also cause other customers to think the quality of the offer is affected and turn to a competitor. That change can be too hard to make for many organizations, and they would be better off creating a new low-cost business entity. It still requires substantial resources but is more realistic in many cases. The new entity would have a different identity, values, and culture, but can still utilize the parent company’s resources and knowledge.
Going back to the example of grocery stores, Walmart reacted to the introduction of Aldi by both competing on price and by differentiating themselves. Loyal to its ‘Everyday Low Prices’ statement, Walmart lowered its prices on some key private-labeled products. It also carried out a price comparison with Aldi to demonstrate that the German chain wasn’t necessarily cheaper. In addition to its efforts on pricing, Walmart also remodeled some of their stores in areas where Aldi had a local presence. It highlighted parts of its assortments that are valuable to customers and can’t be found at Aldi. “Bring it on!” said Greg Foran, CEO of Walmart, when asked about the competitors.
Low-cost competitors entering the market is never good news but should not be ignored. A proper assessment of the situation is necessary. If a new low-cost competitor won’t hurt your sales by stealing your customers, that is great. But, if there is a risk your customers will leave you for this new low-cost offer, changes must be made.