At many of the early Hostelworld conferences, one of the main points they stressed was "Everyone Loses in a Price War," which is misleading. 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 accurate. It took a good conversation over a few beers with a Wharton MBA buddy of mine to really uncover the truth about why.
[pullquote]Do not get into a price war that you cannot win![/pullquote]
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 year's drop in oil prices as OPEC started a price war against the emerging American oil and natural gas industries, which only thrived when oil was over a specific price—say, $100 a barrel. When OPEC dropped prices to $80 a barrel, it became unprofitable for these companies to operate, 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 are some considerations regarding 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 points—the moments at which they can no longer survive.
Again, determine if your competitors can find resources to last through the war. Do not misjudge them. If they can secure investment or a line of credit, this will hurt your chances of success.
Stockpile the capital to survive the price onslaught, operating at a loss until your competitors fold.
Finally, you must prove that you have the resources to do it again, if needed, to ward off potential new competitors.
A properly executed price war should be viewed 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 (compared to the price war, where the consumer is the beneficiary). You could invest in, partner with, or even acquire your competitors. 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 they 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 generate revenue while the beds sell for cheap, and having higher occupancy often brings more guests together to enhance the experience and create valuable word-of-mouth advertising.
[pullquote]Again, do not get into a price war that you cannot win![/pullquote]
Just remember, there will be casualties. Everyone involved (and even those not involved who haven't perfected their value proposition) will suffer losses. Reservations per bednight will come in lower than the cost per bednight. The longer this continues, the more money a hostel risks losing. The real losers, though, will be the agents, specifically the online travel agents (OTAs). Picture the reservations for each geographic location as a pie. There are only so many travelers in any given period. Of course, it could rise and fall, but not enough to significantly affect that pie in the short term, such as on a year-over-year basis. Each year, they expect a certain amount of revenue from each location to contribute to their earnings. A price war can really impact that pie. Even worse, a price war in a popular destination can create a reservations vacuum, pulling bookings from other nearby locations as longer-term guests stay longer in the cheaper areas. This can shrink that pie even further. This is why OTAs will tell you to avoid a price war at all costs because they have more to lose than anyone.
Don't feel 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 for this is their hypocrisy. They have a problem with you creating a price-dropping frenzy to secure a guest; however, they have no problem with you lowering your margins by 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 these schemes, where you can pretty much only opt in and out. That is all. At least with Booking.com's offering, you can be more strategic and use it only on specific dates, building a reservation base at a higher commission before obtaining the rest at a lower rate.
There are plenty of instances now where there is an internal price war, with everyone using one of these promotions, making only Hostelworld the winner. These situations illustrate how easily you can predict the behavior of your competitors, providing insight into whether 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 finish that sentence in your mind with "... that you cannot win!"