Flanking in a Price War Article Main Points Summary The article begins by giving a brief analysis of a study that was conducted in Quebec in the early 1980's involving the grocery industry. It discusses a point of time before the leader in market share, Steinberg, Inc. , initiated a price war. One of the authors of the article, Roger J Calantone, was involved in an experiment with one of the smaller grocery chains, IGA.
The experiment was designed to see what IGA should do so as to retain profitability if their main competition launched an all out price war. The main premise was that certain goods, if prices were lowered, would have more favorable price demand elasticity than other goods. This would enable the grocer to not have to slash prices across the board, rather only cut prices on specific goods so as to retain profitability during a price war with the other competitors. During this time, the other competitors combined had dominant market share. The piece gives a background of the Quebec grocery market between 1950 and 1983, and discussed the main players in the market in this time period.
It specifically discusses Steinberg, Inc. This grocery chain, as previously mentioned, was the market leader for most of this time until 1980 due to some questionable pricing strategies it had implemented as well as some political changes that occurred in the late 1970's. The next point of the article was to discuss a pricing experiment IGA and the author chose to follow to help combat a price war initiated by its competitors. The premise of the experiment was to ascertain if certain goods were reduced in price, while others maintained or increased price, what would happen to overall demand elasticity as well as specific goods' demand elasticity. The goods were divided into two key components and these were: stock-up goods (non-perishable items that could be bought in bulk) and nonstick-up goods (perishable items). The methodology and results of the experiment was discussed in this treatment.
The results ultimately fell in favor of IGA and thusly they were able to effectively fight and win a price war with its major competitors in 1983. Pricing Experiment Design The experiment used a "covariance design within a Bayesian decision framework" to determine that stock-up goods have a different demand elasticity than non stock-up goods. (Calantone, et al, 1989, p. 1) Bayes's Theory is a mathematical formula for calculating conditional probabilities.
(Joyce, 2003) Stock-up goods are those goods that can be purchased in bulk and items which will not spoil such as soap, paper products, canned vegetables, etc. Nonstock-up goods are goods that are perishable and less likely to be purchased in large quantities, such as meats and fresh vegetables. The process studied six different potential outcomes of the goods which were: raising prices of stock-up and non stock-up goods, lowering the prices of both, or keeping the prices constant. Game Theory was tested in the research as well.
Game Theory, as defined by Wessels, "is the study of how people behave in situations where one's actions affect the actions of others." (Wessels, p. 400) According to the authors of the article, "Bayesian decision framework also provided an optimal stopping rule for the experiment." (Calantone, et al, 1989, p. 1) The experiment was conducted over a two week period, and it was up to the management of IGA to decide on continuing the experiment. The researchers wanted at least a two week window "because the covariance matrix sufficiently stabilized at this point." (Calantone, et al, 1989, p. 7) The concern as to the stopping point was to ensure that profits did not decrease dramatically.
Pricing Experiment Results The results of the experiment realized that price elasticity of demand was greater in stock-up goods than non stock-up goods. This confirmed the basis that the study was formulated upon. In addition, it was learned that rather than participate in across the board price cuts, as the competition was thought to do in an all out price war, IGA would be better served only reducing prices of certain goods while maintaining price on other goods. This would help in either maintaining current profit levels for the store or minimizing the loss of profits which would occur during a price war. The Quebec Grocery Market & the Forms of Competition The Quebec Grocery Market was an oligopoly. The reasoning is that the main grocery stores in the market during this time dominated overall market share.
According to the article, there were "four firms [which] accounted for 84. 5 percent of all retail food sales." (Calantone, et al, p. 2) Prior to Steinberg losing its dominant market share, it could be hypothesized that the Market was a "dominant-firm oligopoly." (Wessels, p. 388) Experimental Design Strengths The first strength to discuss in the experiment was using previously conducted experiments in the retail grocery industry as the basis for carrying out new research. The other trials also tested stock-up versus non stock-up goods, and this new experiment built upon previous information which helped formulate the hypothesis on which the test was built and the results accumulated.
The second strength of the test was that by proving the hypothesis valid, it allowed the store to implement a cost effective pricing strategy to counter across-the-board price cuts by its major competitors. This in turn allowed IGA to gain market share during the initial price war as well as retaining overall profitability. Thirdly, using Bayesian decision framework for the modeling of the experiment strengthened it because, according to the paper, "it allowed both an optimal stopping rule for the experiment (to control costs) and a decision based on the executive's utilities." (Calantone, et al, p. 9) By controlling costs, it made the conducting of the experiment possible and ultimately led to a gain in market share for IGA. Had the experiment cost the store too much money, management might have decided against the experiment; thusly, costing more gross margin when competing in an all out price war with the other major competitors. This was proven when examining how the other stores fared after the price war which was initiated by Steinberg.
Experimental Design Weaknesses A weakness in the experiment was only using two weeks of data as a basis for following through with a pricing strategy during a price war. The store would want as much data as possible to rule out a smaller scale market trend that could have occurred during the two weeks. It is my belief that during this small of a time period data could more easily become skewed compared to a longer period of time. Another weakness of the experiment is that it was conducted in a controlled environment without bearing in mind what would happen in a real life situation when competition is involved with this type of pricing strategy. If the competition was able to ascertain the same information prior to the price war, it is possible that the experiment would have failed under real market conditions. Furthermore, the experiment only focused on price; however, pricing may not have been the only factor in the lack of market share for IGA.
The store could have focused on cooperation with its competitors in helping to drive demand rather than engaging in a price war. The grocer could have also conducted an experiment to find out why their market share is lower than its competitors, and what things can be improved upon to help capture additional business. In addition, focusing only on price seems to be a short term strategy since, in an oligopoly, when one firm engages in cost cutting measures all of the other firms will swiftly follow suit. The firm would need to focus on other factors to develop a long term strategy to effectively compete in this marketplace. Price War Pricing Strategies Three of the major competitors had similar pricing strategies, and the fourth, IGA, used the strategy proven by the experiment.
Steinberg offered a five percent rebate on a customers total grocery bill. Provi go followed suit and offered a similar rebate, only they offered six percent. Metro-Richelieu offered similar discounts as the aforementioned competitors, but only on a future purchase. IGA did not engage in the overall rebate or rebate on future orders as its competitors did; instead they offered discounts on all stock-up goods while maintaining price levels on non stock-up goods.
The "Lessons Learned " IGA learned from its pricing experiment that it did not have to follow suit with its competitors given an all out price war situation. They learned that they could still maintain close to current levels of profitability during a price slashing phase in the marketplace. In addition, it was able to conduct the experiment without losing profitability during the experiment phase. It cost very little to test the hypothesis. It also learned that given a price war it could even raise prices of non stock-up goods to offset the lowering of the stock-up goods prices and not affect the elasticity of demand on the non stock-up goods in a negative way. What Did I Learn? I learned that in an market it might be wiser to collaborate with competitors rather than aggressively attempt to drive them out of the market.
The Steinberg grocery chain, due to its aggressive pricing strategy, effectively cost itself market share and profitability. Rather than engage in this type of behavior, Steinberg should have attempted to remain at market equilibrium as it was the dominant player. They should have considered the ramifications of eliminating competition, and what scenarios could potentially occur if they continued on with their current strategies. Bibliography Calantone, R. , Drove, C. , Litvack, D.
, Di Benedetto, C. (1989). Flanking in a Price War. Interfaces, 19, 1-12. Wessels, W. J.
, Economics (3 rd ed. ) Joyce, J. , 'Bayes' Theorem', The Stanford Encyclopedia of Philosophy (Winter 2003 Edition), Edward N. Z alta (ed. ), web.