A price war can wreck havoc in any industry. For small enterprises the effects can even be more catastrophic, and therefore it should be avoided like the plague. Of course, you may have some hard times when some of your competitors show an extreme addiction to discounting, but that shouldn't make you jump into the trap of a price war. It does good to none, and once started it may spread like wildfire and keep getting longer and longer, making things worse for everyone. It is better to consider some smart alternatives.
First of all, I think a small business -- when facing such pressure -- should try competing on quality and differentiation. So, if a competitor is playing the low-price game, don't lower your product prices but try to offer your customers more value. For example, if someone is selling chocolates at a lower price, you may start selling toy-shaped chocolates at your original price. Form, features, performance quality, durability, reliability, or style -- you can base your differentiation on many a factor.
But there is a problem . . . . Most small and medium enterprises (SMEs), with their small budget, usually find it difficult to tweak the tangible features of their products. Similarly, neither is it easy at all to push product quality without allowing your costs to rise. I think these difficulties can be overcome to a good extent by enhancing the intangible features, for example, like superior service, good relationships, reward points programs, etc. If your proposition is already differentiated, just focus on communicating the benefits and value you are already offering.
In addition, some other non-price options, such as forming strategic partnerships to offer exclusive offers to customers can help small firms a lot. So, if your competitor is offering water pumps at a lower price than that of you, try a special deal with a major distributor or an insurance provider to offer exclusive combo offers for any new product purchased from you.
As far as addressing the customers is concerned, try to communicate to your buyers the inherent risk in buying a low-priced, low-quality product. Also communicate the message that in the long-term, they will be the losers too as a long-fought price war forces small firms to exit, after which the big players may hike prices even to a level higher than before.
Nevertheless, in some circumstances you may feel there is no non-price option out but to cut prices. In such situations too, it is better to try smart alternatives rather than a retaliatory price cut. For example, indirect pricing tactics such as bundling, loyalty pricing and other such methods can be deployed to address perceived value. In addition, small firms can also limit the war by cutting prices for some specific channels, sectors or markets, or by introducing less expensive products in addition to the higher-priced one instead of responding with an all-out price cut.
Overall, I think -- the more a price war is avoided, the better it is. And when it comes to small and medium enterprises, it is never a good option to start or engage in one. This, however, doesn't necessarily mean that one should stand on the sideline of the battlefield. In contrast, ignoring such moves can lead to negative consequences, and that's why it's important to act . . . but act smart.