3 ways retailers try to beat the price wars

(MoneyWatch) Black Friday's over, "Cyber Monday" is in full swing and retailers offering even deeper discounts to attract shoppers -- even at the cost of making money. The classic business strategy of making up for lower prices with a higher volume of sales has become a kind of holiday season arms race in which companies compete to out-slash their rivals, wiping out profits. 

As a result, retail giants such as Amazon (AMZN), Best Buy (BBY), Target (TGT) and Wal-Mart (WMT) fight to keep from being undercut and losing customers, as the Wall Street Journal recently reported. According to Best Buy head of U.S. retail operations Shawn Score, all the chains are trying to win customers for the future and not necessarily boost profits during the discount-shopping frenzy.

• Black Friday: 5 tips to save more green
• Five holiday cyber scams to look out for
• Book Gift Guide: 20 picks for the season

That's a dangerous game for businesses, as retailers depend heavily on holiday shopping to boost revenue and profits. For instance, Best Buy has seen a steep drop in its stock price this year even as Wal-Mart, Amazon and Target shares have increased in value.

The problem is that price competition isn't restricted to one part of the year. Outdoing others in the eyes of consumers has become a goal all the time. Here's what retailers are doing to win the battle:

Data mining

Companies have to make decisions based on fact rather than gut instinct -- like bringing the baseball statistics analysis behind the book "Moneyball" to retail. Look at Amazon's attempt to get customers to check prices in stores and then go back to the e-commerce giant to get competing quotes.

The process not only potentially woos consumers, but helps Amazon collect pricing data. That becomes an important competitive advantage, with retailers doing heavy data analysis to keep from losing money. Marketers look for the right items to sell and prices that will be attractive enough to lure shoppers, but without sacrificing profits. Retailers that lack data mining and analysis expertise are at a tremendous disadvantage.

Exclusives and private labeled goods

One way to avoid price competition is to find products that will attract consumers but that have little competition, so there is no pressure to drop prices. Take exclusive product lines. A retailer will likely have to guarantee big sales to the product manufacturer as an incentive to get the agreement. AT&T (T) was a prime example when it negotiated the initial Apple (AAPL) iPhone exclusive. The deal brought many customers to the carrier, but cost dearly, as well. The high level of product subsidies had a major impact on the company's margins and earnings.

Another approach that will likely continue to grow is the use of private labeled goods. These are products that a store has created specifically for itself. Target has been highly effective using this strategy, commissioning name designers to create lines of goods for the company. The retailer gives consumers a chance to buy designer products at low prices, and the same items are unavailable elsewhere.

Skipping discounts completely

A third approach is to get off the sales and undercutting treadmill. Companies with a luxury or high-end service offering geared to wealthier customers might avoid cutting prices to the bone. But relatively few retailers have the types of business that allow such an approach. Even a chain like Nordstrom has Black Friday deals, for example.

Moving out of the discount maelstrom is difficult. JC Penney (JCP) is trying to stop its constant discounting under CEO Ron Johnson, former head of retail at Apple. But it has seen sales drop by 20 percent at its remodeled locations, with the company's stock down by half. The question is whether investors will give Johnson the time necessary to overhaul the business.

But other big retailers may eventually face a similar quandary. Constant marketing by price is a difficult model for a single retailer to maintain. It is potentially disastrous when an entire industry follows. Companies that lack the competitive weapons to fight this battle will need to acquire them quickly, or pay the price.

Image courtesy of Flickr user Robert Banh