The Industry

The Truth About Price Wars

What Last Year's Drop in Oil Prices can Teach You
Dennis Pitcock
Written by Dennis Pitcock

At many of the early Hostelworld conferences, one of the main points they stressed is “Everyone Loses in a Price War,” which is false. If they changed that statement to “Don’t get into a price war, because statistically there is a small chance you would win,” then it would be true. It took a good conversation over a few beers with a Wharton MBA buddy of mine to really squeeze out the truth as to why.

Do not get into a price war that you cannot win!

Frankly, a price war creates a price-dropping frenzy where the only winner is the consumer. There are plenty of examples throughout history, but the best is last years drop in oil prices as OPEC started a price war against emerging American oil and natural gas industries that only thrived when oil was over a specific price, say $100 a barrel. Now, when OPEC dropped prices to $80 a barrel, it was not profitable for these companies to function anymore, so their operations were at least paused until the price rose again (for more detail, see here).

The truth is, as my buddy says, “Do not get into a price war that you cannot win!” This takes extreme strategy, competitive analysis, and caution; way more than just dropping your prices and seeing what happens. So, here is some considerations in regards to how you decide to enter and eventually win a price war:

  • Like OPEC, you have to have the supply, and the capital to do so.
  • Obtain almost insider knowledge of your competition. It is crucial not to misjudge them.
  • Forecast competitors break point, the point at which they cannot survive any longer.
  • Again,  determine if your competitors can find resources to last through the war. Do not misjudge them. If they can land investment or a line of credit, this will hurt your chances of success.
  • You stockpile the capital to survive throughout the price onslaught. Operating at a loss (in profits) until your competitors die off.
  • Finally, you must prove you have the resources to do it again, if needed, to warn off potential new competitors.

A properly executed price war should be looked at as an investment in monopolizing your market. There are other ways to monopolize a market that could be cheaper and result in a greater return on your investment (as compared to the price war, where the consumer is the beneficiary). You could invest in, partner, or even acquire your competitors up. Simply put, if you have the capital, a price war should be one of your last options.

If a price war is still on the table, another simple example is Chinese television manufacturing. The winners held tough, and now have a stronghold in both sales and brand recognition in the market (see here).  Keep in mind that televisions are not a commodity; your beds are. You lose money every night they go unsold. There are other ways to make revenue while the beds sell for cheap, and having a higher occupancy almost always get more guests together to meet one another, working on a better value through experience and word of mouth advertising.

Again, do not get into a price war that you cannot win!

Just remember, there will be casualties. Everyone involved (and even those not involved who haven’t perfected their value proposition) will obtain casualties. Reservations per bednight will come in lower than the cost per bednight. The longer it continues, the more money a hostel could lose. The real losers, though, will be the agents, specifically the online travel agents.

Picture the reservations for each geographic location as a pie. There are only so many travelers per any given period. Of course it could rise and fall, but not so much to affect that pie in the short term, such as a year over year basis. Each year, they expect a certain amount or revenue from each location to contribute to their earnings. A price war can really have an impact on that pie. Even worse, a price war, in a popular destination can create a reservations vacuum, pulling reservations from other nearby locations as longer-term guests stay longer in the cheaper areas. This can shrink that pie even greater. This is why the OTAs will tell you to avoid a price war at all costs, because they have more to lose than anyone.

Don’t fee bad for the OTAs though. After all the good they do, connecting you with your future guests and distributing your beds across the universe, do not consider their bank accounts when deciding to start or enter a price war. The main reason why is their hypocrisy. They have a problem with you creating a price dropping frenzy to obtain a guest, they have no problem in you dropping your margins through increasing your commissions for better placements, to obtain those same guests. Check out Hostelworld‘s Elevate Program, Booking.com Commission Override, or click here to learn more.

Hostelworld Elevate is the worst of which, where you can pretty much only opt in and out. That is all. At least with Booking.com’s you can be more strategic and only use it on specific dates, build a reservation base at a higher commission, but then obtain the rest at a lower commission. There are plenty of occurrences now where there is an internal price war, where everyone is using one of these promotions, making only Hostelworld the winner. These situations show how easily you can predict the behavior of your competitors, offering insight into which maybe the time is right for a true price war.

Just remember, every time you hear someone (especially from an OTA) say “Don’t get into a price war…” you should be finishing that sentence inside your head with “… that you cannot win!”

 

About the author

Dennis Pitcock

Dennis Pitcock

Dennis jumped into the hostel industry after a summer backpacking Europe in 2008. He went from being a guest to a manager within weeks, and currently does consulting for large and small hostels alike in 3 continents. Prior, he worked in eCommerce, so he has passion for the tech side of the industry and is now deeply entrenched in the hostel and activities industry.

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