Are you following the ongoing price war (started with books, spread into DVDs & now into game consoles etc.,) between Amazon & Wal-mart? Who do you think would the winner be? Ok, before even getting to that question, let’s analyze this situation from the game theory perspective.
It all started, when Wal-Mart decided to mark down the prices of ten best-seller books to ten bucks. When Amazon, predictably, matched that price, Wal-Mart went to $9, and, when Amazon matched again, Wal-Mart went to $8.99, at which point Amazon stopped responding, but another major retailer Target matched the Wal-mart’s price leading Wal-Mart to drop the prices further down to $8.98. For now, price war in books apparently stopped at that point, but spread into other products like DVDs & Game consoles.
Now, let’s take a look at the cost structure of the book industry and analyze the impact of this price war. Book prices are traditionally around fifty per cent off the cover price, and these books are now marked down sixty per cent or more, Amazon and Wal-Mart are surely losing money every time they sell one of the discounted titles. So, the more they sell of these titles, the less they are making. (Does n’t that remind you of the Viesta case results, where the busiest person with lot of jobs in hand actually loses money?).
Given this fact, why do companies engage themselves into price wars, in the first place? The hope is that if you cut prices enough you can increase your market share, and even your profits. But this works only if your competitors won’t, or can’t, follow suit. More likely, they’ll cut prices, too, and you’ll end up selling the same share, only at a lower price.
From a game-theory perspective, price wars are usually negative-sum games: everyone loses (Of course, when companies lose, customers win!). A recent study found that, if competitors do match price cuts, industry profits can get cut almost in half. The best way to win a price war, then, is not to play in the first place. Instead, companies should actually focus on their competitive advantage (customer service, quality, coolness etc.,). Companies can also “signal” competitors that they are actually for “stable pricing”, and not interested in starting a price war. The idea is to let your competitors know that you’re not eager to slash prices—but that, if a price war does start, you’ll fight to the bitter end.
If with a little common sense and basic economics, we can demonstrate that Amazon Vs Wal-mart price war is such a bad step, why did not Wal-Mart’s strategists stop it from initiating the price war? And why did not Amazon resist from getting itself into this war? Were they just reckless? Or did this turn into an “ego” issue?
NO, apparently not!! By starting this price war, Wal-Mart is actually making a statement that it’s a player in the online world. From Wal-mart’s point of view, the real goal of this conflict isn’t to lure readers away from Amazon, and it isn’t to get people to buy one of “those ten books”. It’s to lure them online ( to their walmart.com), away from big booksellers and other retailers, and then sell them other stuff. Usually, price wars wreak havoc because they erode the pricing power of an entire business. But, because this price war involves just ten items (that too low priced books), its impact on revenue will be small, and outweighed by the positive effects of all the publicity. Hence this price war may not hurt both Amazon & Wal-mart as bad as it looks on the surface, as it potentially gets them more revenue in other areas and also gives ample publicity!! However, the remaining small players in the book industry are going to be the real losers!! (Squeezed between the behemoths).
