Waging an Effective Price War

First it was the $9.99 (the $8.99, $8.98) hardcover books, now it is $9.99 DVDs. Wal-Mart’s started the price war with a very low price on pre-orders for hardcover books and DVDs. Almost immediately Amazon.com was forced to match Wal-Mart’s price and so did Target. When the three retailers wage this war, customers stand to benefit while shareholders will see value destruction.

The value lost is not uniform for all three retailers. According to WSJ that quotes a JP Morgan analyst, Wal-Mart makes less than 1% of its revenues from its online channel WalMart.com while Amazon.com it is 100%. Online revenue from books and DVDs is even smaller portion of the total revenue. I do not have numbers for Walmart.com but Amazon.com makes 58%  of its total revenue from media sales ($11 billion annual, granted that includes music CDs as well).

The all new low price is offered only on 10 new titles, so their share of total online revenue is low but even a fraction of the 58% is a larger share of total revenue than that of 1%. Wal-Mart may not gain much from this price war but stands to hurt Amazon.com a whole lot more. That is an effective price war.

It is effective not because it added to Wal-Mart’s profit but it forced Amazon.com to respond. There really was no reason for them to match the price.  Let us do back of the envelop math. Let us assume the low price was offered only for a quarter,  the new books and DVDs constitute 10% of the media sales and the margin for Amazon.com is 10%. The price cut is about 30% of their total price, all of which is lost profit. That is a total loss of $82.5 million (11*(1/4)*10%*30%)

Even if we assumed the worst so that Amazon.com’s new book and DVD sales would be completely wiped out had they not matched Wal-Mart’s  price cut, their loss would total to just $27.5 million (11*(1/4)*10%*10%). Clearly, retaliating is not a profitable option for Amazon.com and by doing so they only helped make Wal-Mart’s initial attack effective.

Meanwhile Wal-Mart is only happy to reap the benefits of free publicity from its low cost price war that hardly puts a dent on their profits while damaging their competitor’s profits.

6 thoughts on “Waging an Effective Price War

  1. Chris
    All good questions. Amazon reacted – losing price leadership to Walmart.com (they are the price leaders for Ebook prices).
    New releases are already priced as loss leaders, will further price cuts generate more customer margin? This move also lowers customer reference price, affecting future profits and further aggravating their battle with publishers on pricing.

    Amazon has built a base of loyal customers and made it very easy for their customers to buy from them. They also created further stickiness with Amazon Prime. Will all of them bolt to Walmart.com because of the new releases?

    Amazon that religiously tracks customer buying behavior and runs tests almost incessantly will have data so I could be wrong as well.

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  2. Sid
    $11 billion is AMZN’s annual Media sales (10-K), I should not use the 58% factor again. The 80% should not be there.
    You are correct in saying the book costs could be all sunk and hence MC=0. I do not know how much purchasing power Amazon has with publishers or of there is an opportunity cost of selling the books in bulk to others at a slightly higher price. The bigger negative effect is training the customers to expect low prices (low reference price) and losing out on future profits.

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  3. I believe what is being considered by all sides (players) is a number of additional factors. Briefly, here are a few:
    – –
    1) These titles are essentailly limited time loss leaders to create add-on / up-sells / cross-sells that are more profitable and more likely during the holiday season.

    2) Word of mouth / network effect during the holiday season is magnified significantly and any public buzz that is generated in various forms during this time window represents a lower percentage of the overall (true) buzz (meaning observable buzz during the holidays correalates to a greater non-observalbe buzz than would be the case during a non-holiday time frame). More folks sharing their shopping experiences with more more folks looking for shopping tips . . . results in more sales potential these companies want to position themselves to capture.

    3) Amazon benefits greatly from the year over year growth they are able to report out to generate positive press and tout during earnings calls. Many investors are betting on Amazon to show noteworthy results. Same goes with Walmart and Target, thus this game they play willingly / intentionally.

    4) Convenience of purchase experience favors Amazon for after Christmas purchases (convenience of home versus fighting bargain shopper crowds) and Amazon does not “after Christmas” discount as much other retailers. Amazon also benefits greatly from recency, meaning repeat purchases are closely tied to the number of days since the last purchase or visit to the site. Those who purchase before the holidays are much more likely to return right after, weeks after and even months after the holidays. Ongoing sales potential is significant.

    What do you think . . . am I way off base? 🙂

    Respectfully,

    Chris Hopf
    http://www.pricingwire.com
    Twitter: @pricing

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  4. Not clear about your math at all.
    11*0.25*0.58*0.1 =size of market
    if the gross margin is 10% => cost 90%
    which would lead to a dead loss of = $143m
    what are the 10% * 80%?
    Additionally at this stage it is safe to assume that the books have already been ordered so the cost is a sunk cost. Any revenue is better at a lower price is better than no revenue at all.

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  5. I’ve always wondered about the intangible benefits of price matching. How do customers feel when they find that a competitor has a product for much cheaper? Will my customers trust me more, and maybe use me as an absolute source, if they discover that my prices are always close to the cheapest? How does price matching affect my reputation among customers? I’d love to hear any insights you might have.

    Thanks for the post and blogging.

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