Price Wars

Suppliers don't win price wars, so they avoid 'em. Really substantial profits lie in monopolies (set your own mark up) or where the competitors are small in number and preferably weak. It's allied in nature to the product life cycle, or at least similar in the way it progresses. Let's take a look.

You get a new idea and run fast. If you are successful you sell lots at great margin because there's no real competition. However that soon gets noticed and other people invest in similar designs and start to carve up the market. At first this is a good thing as it expands the overall size of the market, and profits remain high per unit sold whilst increasing volumes lower costs. However more competition comes into the market and there's a point where you can only maintain profit by lowering costs further or knocking off the competitors. So you use innovation, marketing and whatever comes to hand to beat off the little guys. You may make 'em offers they can't refuse or simply leverage your pricing to drive down the price so far that they (with smaller production runs) start to lose money. So the market tends to converge around a smaller number of winners. They get bigger, they keep their big production runs and lower costs per unit and the market settles into smaller price fluctuations that don't rock the boat.

At this point an uneasy truce may reign until someone will either decides they want more marketshare (perhaps they employed an MBA grad) and begin to innovate, or they pare back costs and start a price war. Innovation will keep the price up and refresh the cycle, like Gillette bringing out a new razor or Toyota marketing a hybrid petrol-electric car. However a price war will clearly drive prices down. If it's prolonged then you have a real problem. Once you have cut prices the market is less inclined to accept a higher price again (unless you have obvious supply problems across the board, like droughts affecting farm production) or demand is so great that it simply can't be met (like the world oil price as China ramps up demand).

Got the picture?

OK, so back to PCs. The microprocessor market was reasonably diverse in 1978 with chips from a range of companies (including Motorola and Zilog) that drove the earliest PCs. So prices were high but reasonable given the small production runs. As demand for PCs heated up the market saw some competition in the chip market with various players ramping up production and placing their bets on which designs would dominate. Prices came down. Then Intel, like Microsoft, lucked into a deal with IBM. When IBM stamped its name on a PC (and later on what it called the XT) it created a standard - a beige box with an Intel microprocessor, a monitor, a disk drive (later the hard drive) and an operating system - that is pretty much what we have now, give or take a mouse and a GUI.

What IBM did was expand the market. What happened next was that the market inflated quickly, new players came in and the race was on. IBM's sheer weight drove out the little guys - bar Apple - but gave the 'clones' like Compaq and later Dell a platform to work on. When the profit per unit fell too low IBM sold out. What we have left is a volume market where the only way to make money is to dominate and make lots. Which brings me to Intel. They cashed in on IBM's design and then went with the clones as well. Others tried to compete but Intel's was the standard endorsed by IBM, so they had to catch and then match Intel, who were romping away. In the long run we really only see AMD offering serious competition. At least until something left field - perhaps like IBM's Cell processor or another multi-use but single-die chip - comes along to disrupt things.

Now AMD have both innovated and offered a better price. They have been gaining ground, too. It's still a $US1.3billion minnow fighting against Intel's $US30billion whale, but Intel are hurting. So here comes the price war. Check out the Forbes article.