A Small Step from Price Competition to Price War: Understanding Causes, Effects and Possible Countermeasures

Abstract

The first part of this paper describes the characteristics of price wars, pointing to recent examples that have caused a stir among the public as well as in the respective industries. A new, concise definition of the term price war is suggested. In the second part drivers for price wars are discussed and explained based on behavioral economics (understanding the competitor's strategy as well as a company's own cost situation). Particularly in industries that are characterized by a high proportion of costs that are unchangeable in the medium-term and low variable costs there is a substantial risk for unintended price competition possibly ending in a price war. Even slight price reductions can have fatal consequences when decision makers mistakenly estimate the price elasticities too high. In the third part a case study of a price war is presented by focusing on the market of long-distance bus journeys in Germany. Since the market for intercity bus connections was liberalized in 2013, the newly created market segment faces a very strong growth and intensive competition. Using a multi-source-multi-method-approach it is shown how the market entry of UK-based company Megabus affected price levels for bus journeys und initiated competitive reactions of the German railway operator Deutsche Bahn. The interaction of various parameters (low barriers to enter the market; high similarity of products/services; fixation on market share and capacity utilization) leads to a ruinous price competition and leaves few chances for a sustainable profitability. Measures to avoid an impending or to terminate an ongoing price war are presented.

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“…This is why it is commonly used in game theory to explain social behavior in sequential move games such as ultimatum game and giftexchange game [66]. In fact, such behavior is not limited to games and has been observed in the industry by [67].…”

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“…Brand loyalty and price sensitivity in its basic sense become the indicator to ensure success in gaining customer trust (16). However, managers tend to overlook the importance of dynamics within these two important aspects and often emphasize only on short-term accomplishment through changes in price (17)(18)(19). The results of these actions are often devastating because with respect to customer acceptance, price actions tend to affect and alter their loyalty (20) and switching behavior (10,12,17).…”