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Many companies compete on the basis of low prices. Price wars, however, represent a fundamentally different dynamic than simply trying to get an edge on price. They begin when competitors aggressively and repeatedly set prices below established levels. In some cases, companies that initiate price wars engage in self-destructive behavior, which leads to downward pricing spirals that alter industry structures. In theory, as Meghan R. Busse of Northwestern University’s Kellogg School has shown, there are no winners in price wars: The losers are often forced out of business, and the survivors have been known to suffer a long-term squeeze in profitability.
In studying price wars that took place between 1980 and 2013 in industries including airlines, telecoms and financial services, I saw that price wars were invariably linked with serious drops in financial performance. Indeed, when price wars erupted, most companies found themselves in commodity traps: Profits narrowed considerably, and weak competitors had difficulty staying in business.
The common view in economics and strategy is that a company’s ability to win a price war hinges on having a superior cost structure. However, my research demonstrates that this is not the only way to gain the upper hand. Contrary to most studies, I found that, under the right circumstances, it’s possible for a company to win a price war by leveraging a specific set of strategic capabilities. Specifically, these include the ability to read the business context and how things are changing, the skills to analyze the market data to identify trends and opportunities, and the pragmatic wherewithal to implement organizational changes both internally and across the value chain. Such was the case of Albert Heijn (AH), a Dutch company in the grocery industry, during a price war it initiated in the Netherlands between 2003 and 2005. AH showed that winning a price war can have as much to do with a company’s strategic capabilities and skills as its relative cost position. The case provokes new thinking on how companies can influence price war outcomes, suggesting that other companies might be able to achieve success by establishing five rules of engagement. The rules will help managers frame the contextual, analytical and pragmatic capabilities by helping them 1) affirm the need, 2) pick the battlefield, 3) pick the target, 4) stay under the radar and 5) align revenues with cost structures and rally support needed to succeed.
Affirm the need.
If your industry is mature, slow growing and relatively stable, then sooner or later you may face a price war. Under these circumstances, the best thing you can do is to prepare yourself. In 2003, Dutch retailers including AH, a subsidiary of Royal Ahold N.V. (ranked 249 in Fortune’s Global 500 list in 2013), and Laurus (which operated three large supermarket chains, including Super de Boer) were losing market share to discounters such as Aldi and Lidl, both based in Germany. The competition was intense. By studying market data, AH was able to identify shifts in customer purchasing patterns. Although AH was selling new and higher priced items, it was seeing fewer families among its clients and a sharp decline in high-volume products. Dick Boer, the AH CEO at the time, and other executives wanted AH to be “a supermarket for everyone” even though its leading competitors had cost structures that gave them a 6% advantage. What followed was a fierce price war.
Pick your battlefield.
Staying alert and aware of trends in your industry is just the beginning. Companies in mature and commoditized industries also need to have analytical capabilities to develop new strategies and then be able to implement them in a timely manner. To conserve resources, they need to pick their battlefields carefully. Retailers, for example, have to decide whether to cut prices geographically or target specific customer segments and products. Ideally, you want to avoid direct confrontations with cost leaders. And there’s also the question of timing: Should you cut prices when you think consumers are paying attention or to coincide with the launch of a competitor’s new product?
Market research showed AH’s market share had fallen by almost two percentage points in the second quarter of 2003, indicating that consumers were clearly interested in bargains. The company was under a lot of pressure to show that it was able to grow its business, Boer recalled, which meant that it needed to find a way to cut the price differential with competitors from about 10% to 5% or less. Fundamentally, he said, this meant making changes in the organization.
In October 2003, AH announced major price reductions, the most significant price cuts in its 116-year history. But it was careful not to attack the discounters. Indeed, rather than positioning itself as the retailer with the lowest prices, AH wanted to be mid-priced and service-oriented. In a sense, by defining the battlefield the way it did, AH chose a middle course in hopes of limiting the price war.
Pick your target.
It’s difficult and expensive to take on everyone who has a business model similar to yours. It’s much easier to go after a single competitor who appears to be vulnerable. Specifically, AH needed to decide whether to reduce prices directly or indirectly (for example, by adjusting its service levels). The data showed that AH’s market share was suffering in part because consumers saw it as high-priced. So rather than competing with discounters on prices of major brands like Coca Cola, management chose to emphasize private labels, including milk and other frequently purchased dairy products. In an effort to win back customers, it announced new pricing policies in TV and newspaper ads that proclaimed, “From now on, your daily groceries are much less expensive.”
Stay under the radar.
By targeting its own former customers as opposed to the established customers of rivals, AH hoped to boost market share without provoking a strong reaction. It worked. The initial reaction from competitors was muted, allowing AH to focus on what it saw as its weakest competitor: Super de Boer, Laurus’ flagship chain. Although Super de Boer was less service-oriented than AH, it was seen as less expensive. AH sensed vulnerability: Laurus, Super de Boer’s parent company, had had weak performance in recent years.
The price reductions that AH announced in October 2003 caught the industry by surprise. Internally, AH management had made a point of keeping discussions about its plans quiet, limiting the number of people who were part of them to fewer than a dozen for fear than the plans would leak. AH management waited until the very last moment before informing store managers of a 7 a.m. conference call the next morning. In its eagerness to keep competitors guessing, AH refrained from disclosing its plans to major suppliers. Only when it was clear that operational changes would allow AH to cut costs did management initiate discussions with manufacturers. A few days after the opening salvo of the price war, AH called a meeting with the company’s 10 most important suppliers to ask for support.
AH used its advertising dollars to rebuild its price image. The company tried to strike a tone of being steady and predictable; it wanted to be seen as helping customers shop for less, rather than being aggressive or threatening to competitors. Over the next two years, AH showed remarkable patience and discipline. In the face of doubts by some analysts about its ability to win the price war, which were reflected in a falling stock price, AH enacted several rounds of price reductions, proving to both consumers and industry experts that it was serious about its new pricing strategy. “[AH] constantly came with new waves of price reductions,” recalled a pricing strategist at a rival company, making it difficult for competitors to predict when or whether a new round was coming.
Each week, AH gave its pricing strategy a different focus. One week it targeted cheeses; the next week it was cosmetics or baby food. Within four months, the company managed to win back many customers it had lost between 2000 and 2003. In the face of AH’s assault, competitors had to decide how aggressively they should respond. Initially, for example, Laurus matched some of AH’s price reductions. But after a few months, Laurus concluded it had to be more forceful; in January 2004, it announced price cuts on 40 popular products by 24 to 43% percent.
As the owner of three supermarket chains, Laurus had to develop different retailing strategies for the different retailing formats. When Laurus finally enacted broad-based price cuts in the spring and summer of 2004, the impact was far less powerful than the company hoped for. Soon thereafter, AH unleashed a major assault, cutting prices on 2,000 products by up to 35%.
Align revenues with cost structures and rally support.
Companies can’t pursue pricing policies in a vacuum. Management needs to make sure that their pricing decisions are aligned with their cost structures and the broader value chain. In an effort to protect its gross margins, AH initiated steps early on to reduce headcount and improve operational effectiveness; in management’s view, rebuilding market share and winning back consumers had to go hand in hand with restructuring the business. This meant staff reductions at headquarters, consolidating operations of similar businesses and, as much as possible, streamlining (or, in some cases, automating) activities such as merchandise ordering and replenishment. For example, AH shifted its ordering process from its 600 individual stores to one central office. While revenues fell initially, reducing operating costs helped AH generate profits on lower revenue, which softened the blow. Yet even as AH became leaner, it didn’t give up pursuing ways to innovate and provide additional value to customers. For example, it added children’s play areas in stores and introduced new brands, such as “Choose & Cook,” which was aimed at making it more convenient for shoppers to find the ingredients they needed to prepare certain meals.
Once management made decisions about which policies to pursue, it constantly monitored their effectiveness.
As the initiator of the price war, AH had begun making its plans before competitors knew what was coming. Then, after demonstrating resilience early on, AH was able to negotiate valuable price concessions from suppliers, much to the consternation of its main rivals. Laurus was unable to leverage its bargaining power in the industry for several reasons. First, integrated purchasing and negotiating across multiple formats is difficult; each format has its own processes, procedures and bureaucracies. Second, Laurus was playing catch-up to AH when trying to negotiate price concessions from suppliers. Finally, Laurus’ response was too little, too late; only after the price war was in full swing did it begin looking for ways to increase efficiency and reduce costs. While AH’s stock price declined by 2.3% in 2003, Laurus’ dropped 21%. By January 2005, industry analysts and even Laurus CEO Harry Bruijnuiks were well aware that the price war was going poorly for Laurus. Bruijnuiks admitted in an interview: “We are at a price level that is worrying. Costs cannot be covered, or only just.” He added, “I think the price war is not over yet.”
Laurus lost money in its 2004 and 2005 fiscal years, and its management decided to sell off the bulk of its operations to focus on its Super de Boer chain. By contrast, AH regained the market share it had lost prior to 2003 and assumed the number one position in the Dutch grocery retail market. Holding onto that position hasn’t been easy, however, particularly in light of the recent economic weakness in Europe. In fact, some analysts say the signs may be pointing to another prolonged price war in the Netherlands.
This Dutch supermarket case underlines how important it is for companies to have a clear, targeted agenda in a price war (for example, winning back former customers), and to understand and adhere to the established rules of engagement. With focused attention, fact-based decision making and strong execution, AH succeeded in changing public perceptions about its market position using well-timed price cuts, clear communications, operational integration and support from its supply chain. Once management made decisions about which policies to pursue, it constantly monitored their effectiveness.
Winning a price war may not be a major achievement when you are the industry cost leader. However, as AH’s experience demonstrates, you don’t need to have the best cost position to start and win a price war. In fact, having strategic capabilities such as market awareness, analytic skills and the ability to execute effectively can be more important. Although AH was disadvantaged on cost, it launched a price war and won — something other companies can learn from.