How to survive the next price war

By Alissa Chen and Koen Pauwels

Price wars are in the air again, as companies aim to survive or gain the upper hand in these tough times, when customers are ready to change existing habits. When United Airlines announced it would cut change fees ‘forever’, Delta and American Airlines followed suit the next day. It reminded me of how competitors dropped prices within days of Dutch retail chain Albert Heijn starting the Great Price War that reduced food prices 8% and cost 30,000 employees their jobs. I was recently interviewed by Alissa Chen (for the DATA initiative at Northeastern) about the two Journal of Marketing Research papers analyzing these events, available at http://marketingandmetrics.com/wp-content/uploads/2020/06/39.-Winners-Losers.pdf and http://marketingandmetrics.com/wp-content/uploads/2020/06/11.-Fanning-Flames.pdf. The short transcript follows:

Alissa: Why don’t you walk me through what the paper is about?

Koen: In the Netherlands, we had really the legacy of about 30-35% market share grocery store, Albert Heijn. They had been suffering for years for their declining price image. Albert Heijn was known as this kind of legacy player, very good service, beautiful stores but had been suffering from you know you pay a higher price than at some other places and so that competition was both from supermarkets that are similar to them also high service and of course they were very concerned with the hard discounts. So in America hard discounters are typically like a Walmart you know, coming in with lower prices. In Europe it’s mostly the German discounters, Aldi and Lidl. They enter every European country with a much lower price. They keep the prices down because most of what they sell is what we call the private label. Most of the stuff they sell is from suppliers that don’t put their brand on, so it’s branded by the store. They can keep prices very low because these brands don’t advertise and so forth. Albert Heijn was really afraid for its market share. In all the studies, people said: “Well, Albert Heijn has fantastic service, fantastic quality, but they really have a bad price value relationship.” So why is it important because in the Netherlands? People, even very rich people, pride themselves on finding the very best deals. Overnight, they completely cut the prices permanently and it was a huge price reduction – it was 10-20% on 1000 items. So not just on a few things, they committed to do that permanently. It was not a price promotion. Their objective was to become average priced in the market. In a place where right now there were the highest price ones. That was the major kind of shock. Within two days, other retailers followed and we saw prices going down for years to come. The retailers would squeeze their suppliers. Lots of retailers were actually selling items below costs. It was very well discussed in the press and in society. It was fascinating to see how consumers react.

Alissa: That’s actually really interesting that they were selling it below cost because I feel like that wouldn’t be very sustainable in the long run.

Koen: It isn’t. Why on earth would anybody want to enter the price war? If you can foresee that if you drop your price, your competitor drops too, you have about the same market share, you just have less money. The only reason it really makes national sense, if you can hurt your competitors more than yourself. Meaning if you have deeper pockets, then getting into a price war is good if your competitor goes out of business. So you have that a lot when people talk about price wars and airlines. Airlines constantly had price wars, at least before 9/11. A price war is very likely to happen when most of your costs are fixed costs. In an industry with lots fixed cost, you always see these price wars coming on to the field.

Alissa: I did a little bit of research and between June 2019 and May 2020, 4 US airlines held over two thirds of the domestic market share. So these four companies were Delta, American, Southwest and United. And when I dug a little bit deeper, I found out that even before the pandemic Southwest did not charge ticket change fees. Why do you think these three companies decided to implement such a similar change now, as opposed to following suit with Southwest earlier?

Koen: That’s a great point. So again, it’s about psychology. Not everybody knows that Southwest doesn’t charge it. At the time that Southwest either came up without it, or did away with it, the legacy players didn’t think it was in their best interest to follow. This is just a revenue calculation. Every time that you can change the price, you try to estimate the price sensitivity of your customers. If Northeastern kind of increases the price of education by 10%. If it has the same demand, it has 10% more revenues. If you think about it, just from a short term optimization, demand would have to fall by more than 10% to make a price increase wrong for our revenues. Similarly, the other way around too, suppose Northeastern cuts the price by 10%. Our revenues would go down unless we increase demand by more than 10%. Companies constantly think about: “How can I increase my prices and get away with it without hurting people’s psychology?” If you think in airline travel, there’s the consumer segment and the business segment. Business people typically have to fly at a certain time. They are typically not sensitive to price. These are all situations where as a company, you try to find all the ways to increase prices, because your market is not very price sensitive. But in consumer travel, you can just go to a competitor, postpone travel, or travel in another way. You’re going to be much more price sensitive. The way you get economy people is with a low price. Then they make up for the margin in their business segments where they have increased prices because those customers don’t care much about it.

Alissa: I found that published research kind of has a tendency to be very rich and some would say dense in information. So how would you recommend people who are simply looking to get a better understanding of a particular topic to approach reading such a long article?

Koen: That’s a great question Alissa. First of all, it has to be dense, because the journals require us to put everything in about 25 pages of double spaced. I recommend people to scan the abstract first. In the abstract, the authors define the problem, what we did, and what the interesting findings are. If you like the abstract, then you read on and then I always say, read the introduction and read the conclusion. That’s it. When these are promising, read past the introduction for the conceptual framework, often expressed in a figure. What are the hypotheses and which data was used to assess them? And then comes the methodology with detailed findings. I would only go into the data method if you find something is too surprising. If something doesn’t seem right to you, I would always go to the data and the methodology to say: “Is that something that the authors did that that shouldn’t be justified?”

Alissa: Thanks for all the insights and opinions professor!