| Blood in the Water |
25 August 2003
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Dell Cuts Prices Despite Greater Demand
Dell Computers announced last week that is was cutting prices on its computers by as much as 22%. Simple economics says that with demand increasing with back-to-school shopping, suppliers can get more for their products. Then, why the cut? Because contrary to popular opinion, businesses do not simply maximize profits, they engage in fights for market share and positioning in the belief that a sacrifice of gains now will result in bigger stock prices later.
The reason that Dell cut prices according to many is the result posted by rival Hewlett Packard, which posted its first ever loss the day before Dells cuts. Dell merely said its new prices were "serendipitous." HP more plausibly claimed, "It's a two-horse race, and Dell knows it." Someone is misinforming the public, but the fact is that Dell is lowering its prices as HP is showing signs of trouble.
Regardless of plans and intentions, Dell is in the position of grabbing marketshare with this move, even though its per unit margins will not be as high. Indeed, depending on the slope of the demand curve, overall revenues may not be as high if increased volumes don't make up for reduced prices. But that doesn't matter right now. What is important is that Dell's cuts will cut into HP's market share.
Ultimately, this becomes predatory pricing, where prices are reduced to the point where one of the suppliers can't continue -- then the consumer's party is over and prices soar. Dell and HP are a long way from this, and there are some computer makers that will fill any gap. Still, it is a perfect example of economics oversimplifying the business process. Lowering prices in the face of increased demand makes no sense to in economics class, but it is the first lesson in business school.
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