Differentiation is essential to escape the price war

When a person has a business idea because it senses that there is great potential in it often makes the mistake of wanting to copy the entire competition, to be near her to grab their customers and offer a lower price to enter and win them all .

This pathway probably leads to the competitor, in turn, lower prices and this becomes a cycle, in a price war that ultimately led the two to charge the least for their products and not getting expected profits.

Columbia Ideas at Work Business School published an article on the studies currently being conducted by economics and business professor at that university, Michael Riordan, using game theory to see how they react to business owners when new firms enter the market to compete .

Riordan sums as follows: "The key issue is to design products to avoid direct competition, so that there is a substantial number of consumers in the market that are more or less indifferent to its product line and its competitor . Because if any, will be tempting to try to attract them through lower prices.

Enter the market without causing a price war

Riordan says that if it is known to enter the market with a well differentiated product that is not interchangeable with the competition and therefore not as sensitive to price changes, it is likely that prices instead of lowering, increase because each will be making the most of its segment.

This may be clearer with the example mentioned in the article by Columbia Ideas at Work, in which an aspiring entrepreneur sees a business so full of coffee near a college where many people walk, and decides to open a coffee business the whole front, across the street.

The reaction of the old business is cutting prices to fight for their customers, leading to the new employer also decrease, obtaining much lower profit margins than expected.

But the proposal discussed in the article is that if the entrepreneur decides to enter differentiated, can open a tea shop specializing seeking to attract that segment of customers in the coffee shop they prefer the new product and would not change because of differences in price, which would provide incentives to the former business owner to lower their prices, and instead could take them up to maximize the profits of the coffee drinkers.

According to Riordan, "The profit-maximizing price of the establishment of coffee depends on the price charged by the establishment of tea, and vice versa" and it will be agreeing to stable prices.

Product differentiation strategies

According to these studies, before entering a market, there are three questions to be considered in order to create a product differentiation strategy that maximizes profits:

1. Is there a customer segment that is not well served by existing firms? There are consumers of all types, some are willing to pay more for certain products without deciding other driven by lower prices. If you can create a product with added value for those customers who are willing to pay more for it, you can capture some of that value through higher earnings.

2. How much difference should be within their own product line? Advanced segmentation creates value for customers because they feel they are offered something to measure, but be careful about the way in which this segmentation affects other products and the level of variety so that it becomes profitable.

3. How will existing firms respond to entry of new business to the market? If many clients see the new product as a possible replacement of the foregoing, the owner of the latter cut prices. But to avoid this, you can segment the product so that customers prefer one or the other, regardless of price.

The key is to offer a unique product that meets specific consumer needs and having an aggregate value for which they are willing to pay, as this is what ensures the success and permanence of the product without relying on other bids.

In Riordan's words "What makes the entrance, ideally, is to reorganize the consumers in the market, so that the new consumer segmentation among firms, they are less price sensitive."