Gateway operates within a capitalist economy. A capitalist economy is where people are free, within the bounds of the law, to engage in commerce at their will and their peril. Free markets are characterized by open competition and survival of the fittest. As in the natural world, grow or die is a constant imperative in the business world.
As any economics text book will tell you, smaller participants face an uphill battle when competing against established giants in an open market. Smaller firms seeking to enter or expand will invariably face price-cutting by larger firms. The latter use their superior financial power to drive rivals from the field and then raise prices to recoup their losses.
This is exactly what happened to the fledging Compass Airlines when it tried to break the Australian Airlines/Ansett Airlines aviation duopoly. The drastic cutting of prices by the dominant incumbents at the time led to the extinction of the new entrant. Compass was declared bankrupt and thousands of passengers were left with worthless airline tickets.
Over the past year we have experienced a similar price war in banking, albeit with a slight twist. Each of the Big Four banks has tried to capture market share from the others and smaller players have been caught in the cross-fire of this mortgage war. The scramble is on to write more home loans and poaching customers is the name of the game.
The banking sector is not the only industry to be racked by price wars. Grocery retailers have been stuck in a price war for years. Tele-communications companies have also experienced a drop in prices. The automotive industry has been offering incentives to drive up sales. And gas and electricity providers have started to offer energy plans.
The $64 question is this: Do consumers really benefit from price wars? Angela Paladino, an associate professor in marketing at the University of Melbourne, answered this question from the standpoint of shoppers and the benefit or otherwise they derive from supermarket price wars. She writes:
Price wars squeeze out marginal players and change the composition of the market. Here fewer competitors seek to enter an unattractive market that is dependent on low price for success, and smaller competitors exit the market as a result of the inability to make a profit. Others may be taken over....This has a long-term impact on consumer choice, with shoppers left in a market comprised of fewer players with greater power.
This is indeed the case for supermarkets and I would argue other industry sectors as well. There are rarely real winners in a price war, only bruised survivors. Everyone can participate in a race to the bottom - price is not a competitive advantage as it can be copied easily by the competition. There is always someone with deeper pockets willing to undercut you.
The most common driver of price wars is the desire to increase market share. By reducing your price more people will choose your offering. However, your competitors are unlikely to sit back and let you take their market share so they also lower their price. The end result is that both companies have the same market share as before, only at lower prices and reduced profitability.
We all like a bargain and Australians are adept at voting with their feet to get a better deal. There’s no doubt that the average consumer does benefit from price wars in the short-term, but what about the long-term consequences? The decision last year by Coles and Woolworths to slash milk prices to $1 a litre didn’t increase consumer demand for milk. But it did take customers away from smaller independent retailers.
The corner store is fighting for survival and may go the way of the local hardware store. I still pine for my local, family-owned hardware store which provided a level of personal service that today’s industry giants with their mega-barn outlets can’t match. I, for one, am always happy to go to a smaller provider and pay a bit more for personal service. Big is not beautiful!
Regards
Paul J. Thomas
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Posted Monday, May 14, 2012 
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