How low can you go? What to do with a price war?

November 6, 2018

What to do with a price war?

A price war can be a unique opportunity to distinguish yourself and gain a strong position in the market, but it can also mean the end of your business. It is therefore very important to deal with this properly. In two articles we give you tips on how you can get yourself through it.

  1. How low can you go?
  2. A powerful battle plan for a price war!

Today we focus at the first article and look at how low you can make your prices.

How low can you go?

To keep going along with price drops is not always a good plan. What is the bottomline for you, when does it become too absurd or no longer profitable to come along? It’s good to calculate how low you can go by yourself. But how do you do that?

Perhaps even more important: does a price war fit with your company? If you profile yourself as the cheapest web store, then yes. Or maybe you try to distinguish yourself in terms of quality, service or something else. You do not claim to be the cheapest, but the best on a different level! Then it may be rewarding not to go blindly along with your competitors, especially if you already have loyal supporters.

By only going lower, always receiving less margin, you finally work yourself into the problems. You get less money for the same time, because it is not guaranteed that being the cheapest also means more sales. You will deliver less of what you want to distinguish yourself with. Instead of buying quality products, you go to cheaper suppliers and your quality decreases, but the amount of returns increase. The service is getting worse, because instead of talking to your client, you have to invest time in research on how to make more money. That is the ideal way to lose a price war. In short: only participate in a price war if this suits your company!

But how do you know how low you can now?

Calculating the cost price

To know how far you can drop in your price, it’s important to know what your product costs to make and ship. Knowledge is often the most important weapon in a price war. The cost price is the minimum value of your product, so as not to suffer a loss. You calculate the cost price of a product by calculating the fixed and variable costs of your company and products. Do realize that, if you sell your products at cost price, you break even and you will not earn anything.

However, it does not stop at the fixed and variable costs! You also have to take into account what you expect to convert and what you actually do.

Suppose you have a nice calculation of the fixed costs and variable costs. Then you also have to take into account a realistic break even. Suppose you calculate that your product costs $1.84 to make, including EVERYTHING. You decide to sell it for $2.50. To cover all your costs, such as storage, equipment, gas, electricity, water, wages etc., you have to sell 10,000 products per month. Research shows that the national monthly demand for the product is 35,000. Well, you think, I’ll get that 10,000! No you won’t! You’ll only sell 10,000 if there are only 3,5 suppliers and the distribution is evenly distributed (the Nash equilibrium). Presumably, there are hundreds of suppliers of your product, both at home and abroad. Being the cheapest usually also results in most sales (if you are easy to find).

In short, in your cost price you also have to consider how much you expect to sell. Look for data from the past months. Don’t have that? Then start in the first month of sales with a relatively high price. You can adjust your price downwards and nobody will look sour. If you start too low and throw your price up, no one will appreciate it and you will definitely lose customers. So make a calculation of:

  • Fixed costs;
  • Variable cost;
  • Break-even point;
  • Expected sales;
  • Actual sales.

Make it integral

I actually hate this word. Nowadays everything has to be ‘integral’, but without anyone knowing what it means …! In this case I will make it specific. Make sure that, if you have multiple products, you align the prices.

In order to win a price war, for some products you can go below the cost price. Indeed, you will lose money. However, this can produce money in the long term. The Citroën case is a perfect example of this:

Around 2012, the C1 models from Citroën were very popular in the Netherlands. They had no ‘added tax’, were economical and practical and actually the ideal carpool / shopping car. They sold like hot cakes, precisely because they cost so little. What few people know is that dealers lost money selling a C1. Than why did they still sell these cars and how does this fit in a sensible strategy?

Simple: After a few years, they will earn themselves back. Then inspections must take place and maintenance is necessary. The more cars in maintenance, the more income from the garage!

In addition: many people with a higher income were looking for a second car that was cheaper. After all, there was still a crisis, so the richer segment also had to pay attention to their expenses. Married couples often came to hand in a nice ‘shopping car’ the woman had used for the groceries and to bring the children to and from school. The C1 was cheap, since there was no added tax, it used little fuel and maintenance was cheap, so they exchanged their own second car for the cheaper C1. The C1 was, however, not abundantly present in the showroom. The larger, masculine cars were shown instead. When a couple came looking for a C1, the man was seduced to change cars also. This way, not only a C1 was sold to the woman, but also immediately a larger and luxurious car for the man. The bigger car also had a bigger margin, of course. This compensated for the loss on the C1. Not even a bad strategy. Especially because now two cars are in maintenance!

By charging under the cost price with certain, highly sought-after products, you attract more visitors to your web store. By highlighting related products prominently, you can convince the visitor to buy a combination. You will make up for the loss through extra sales of other products. If you buy a keyboard, you might as well immediately buy a standard for it. And a microphone. And sheet music.