There is a particular industry with low barriers to entry that was running at 100% capacity a year ago. Due to the demand and the low barriers to entry, new entrants came in and acquired equipment with massive amounts of debt. Now, a year later, capacity may be around 50% and the equipment has lost half of its value.

Since there are multiple competitors in the industry they are competing on price to keep their equipment running to cover overheads and service debt.

If you were in this industry and could sustain heavy losses, wouldn’t it make sense to compete on pricing because, presumably, you would have a lower cost structure, due to the debt load of the other participants in the market? Wouldn’t it be possible to put them in a position in which they couldn’t cover fixed cost or service debt? In turn, wouldn’t this be better in the long run since you could gain market share and pricing power?

THIS IS MY RESPONSE TO THE COMMENT

If you have a clear cost leadership position and customers are price sensitive it may well make a lot of sense to compete on price in order to drive out your competitors. However, there are a couple of things you may want to think about.

First, once you lower your prices you will establish a new price point in the mind of your customers and unless this is a price at which you are able to make a profit on a full cost basis you will need to raise it at some time in the future which might be easier said than done. In the meantime you may only be recovering your incremental costs and when demand does start to rise you may not be able to achieve your full profit potential. Second, even in cases where it might make sense to drop price for capacity management reasons I would urge you to take a close look at the opportunity to have differential pricing for different products or services simply because these probably represent different “values” for different customers. This is particularly relevant (a) if consumer demand for the industry output is inelastic meaning that price is not the main driver of sales volume or (b) the business has a unique opportunity to differentiate itself on the basis of non-price factors that are important to consumers.

Understanding what your various product or service offerings are worth to different customers is invaluable information that is ignored by many businesses. If you are able to determine value points and price accordingly you will not only put pressure on your competitors (there’s nothing very smart about the highly visible and easily copied strategy of dropping prices across the board) but it will also enable you to maximize your own profit in the process. This will not only help you in tough times it will take you to the front of the pack in good times.

One of the best references you’ll find on pricing is Holden & Burtons’ book Pricing with Confidence: 10 Ways to Stop Leaving Money on the Table. It’s a reference that every business manager should be reading during this phase of the business cycle.