(FORTUNE Magazine) – NOTHING LAYS WASTE to a business landscape like a price war. Engaging your competitors in a pricing battle will likely savage your company and scar your industry for years to come. The casualty list can be appalling. Customer loyalty? Dead. Profits? Imploding. Planning? Up in smoke. Given the massed armies of capital and capacity that most competitors command today, there's less hope than ever of winning a price war. Endure maybe, but walk away * whistling ''Dixie''? Brother, you're dreaming. Learn the new set of rules. Rule one: Price wars, a fact of life in businesses such as airlines, tobacco, and long-distance telephone service, are likely to spread to other industries in this era of ultracompetitiveness. Differentiating your product is far more difficult (try differentiating a phone call). So is the tactic of becoming the lowest-cost producer by just chipping away at your existing cost structure, since every company is aiming to be the No. 1 cheapo. The only way to vanquish desperate, deep-pocketed, dumb-money competitors is to reconceive the way you do business or, to use a coming phrase, reframe it. The handful of companies that have won their battles -- from far-flung fronts such as pet food, PCs, and medical products -- offer an invaluable set of battle plans for doing business in the 1990s. They've fashioned premium products where none existed, picked up cost advantages through vertical integration, partnered with suppliers, unearthed cheap raw materials unavailable to rivals, or identified new forms of distribution. ''Only the company that breaks out of the box to fight, wins,'' says Gary Stibel, president of the New England Consulting Group. That means rethinking your work process like H.J. Heinz and reinventing how your customers buy your products the way retailer Best Buy did. Think you're in a commodity business? Think again and turn a generic ugly duckling into a value-added swan, as mortgage banker Arbor National did. Or emulate carpetmaker Shaw Industries, which pieced together market share and then integrated vertically, creating a power position in its industry. Revolutionize your product and forge alliances as Becton Dickinson has. Or find a profitable niche like Tri-Star Computer, even in an industry that is commoditizing rapidly.

Haven't heard the drums of price war beating in your industry? Don't be surprised if you do soon. Reason: The root causes of these conflicts are still with us and aren't about to abate. Capacity utilization, while rising in many businesses, is still below peak levels. For instance, in food processing, capacity is holding steady near 80%, almost six percentage points below historical highs. The aluminum market, which is swamped with global capacity, is also running at about 80% capacity, more than nine percentage points off its historical average. Meanwhile, those reengineers cranking up productivity down at the old plant are in effect adding to capacity.

Though the Federal Reserve has knocked up short-term interest rates to keep the nation's pace of economic growth in check, most companies, particularly on the consumer side of the economy, are hard pressed to raise prices one iota. Retailers struggle with disinflation as consumers play How Low Can You Go with discounters, warehouse clubs, and category killers; the killers in turn point their price guns at suppliers. Some businesses are particularly susceptible to price wars. According to Jon Mark, a director of Bain & Co. in Boston, a market with a high percentage of low-end product -- ice cream, say -- is in the danger zone. The worse- positioned company is one that sells mostly cheap goods in a market dominated by low-end product, since getting the edge in that situation is most difficult. ''That's when it's time to completely rethink your strategy,'' says Mark. ''Your best move would be either to trump or dump the business.'' War is also likely in industries where the price gap between brand-name goods and private label is huge, such as the almost 70% difference in crackers and over 45% in cookies. Companies in industries with little or no barriers to entry are also vulnerable, as well as those with easy sources of cheap capital. Note the falling fees in credit cards. How bad can a price war be? Awful. Devastating. Take tobacco. In April of last year, Philip Morris cut the price of Marlboros 40 cents a pack, to about $1.80. RJR wheezed and matched the cut. By the end of the year domestic operating profits for the two companies plummeted for the first time ever. How far? Far. From $2.1 billion to $1.2 billion for RJR and from $5.2 billion to $2.8 billion for the Marlboro Man. Philip Morris stock dropped from about $64 a share before the markdown to the $50-a-share neighborhood, which translates to a $12 billion loss in market capitalization. Philip Morris is claiming victory. True, Marlboro's market share is now 27.3%, compared with 22.1% last March, while the share of RJR's Winston brand has inched up from 5.9% to 6.2%. But is that the best scorecard? Domestic operating income in Philip Morris's tobacco business in the first quarter fell about 25%, from $1 billion last year to $769 million this year. Shareholders probably aren't in the mood to break out the champagne quite yet. The flaw in Philip Morris's plan, and many like it, is that you can't -- presto! -- offset lower prices with higher volume. Elasticity of demand won't stretch far enough to pull you back. According to work done by McKinsey consultants Mike Marn and Bob Garda, the typical S&P 1,000 company would need a 12% increase in sales volume to offset a 3% price cut. That's because variable costs that come along with increased volume drag down profits (see table). Typically, unit cost won't fall until sales increase about 20%. In fact, Marn says, a price cut of 3% usually produces only a 5% to 6% increase in volume. Take Philip Morris again. It cut prices 18%. The company says unit volume climbed 12.5% in the first quarter of this year. But remember its profits fell 25%. A strategy goes up in smoke.

A price war can hurt a business for years, because it encourages customers to focus only on a product's pricetag, not its value or benefits. And consumers remember the rock bottom. When airlines cut the round-trip fare between New York and Los Angeles to $199 in the summer of 1992, in the minds of consumers they established a new benchmark price, and there it remains. And contrary to that old saw, price wars usually don't ''shake out'' an industry. In businesses with mega-assets, such as airlines, food, and packaged goods, capacity never goes away. It often seeks Chapter 11 and emerges with lower costs, particularly in the airline industry. Other troubled companies sell off factories cheap to an entrepreneur who then waltzes in with a minuscule ROI threshold. Most price wars could be avoided. Many begin by accident, through a misreading of a competitor's moves or a misjudgment of the marketplace. ''One price war in industrial electrical products started when an industry trade journal mistakenly inflated the total market volume number by 15%,'' says McKinsey consultant Marn. ''The four major players all thought they lost market share and dropped prices to recover what was never really lost.'' Fully understanding your competitors' motives is critical. Except in industries like PCs where prices are constantly falling because of cheaper technology, price cuts are often temporary and targeted at specific markets or customers, or they're made to move excess inventory. Slashing prices seems like good defense, but the strategy can easily scorch the earth. H.J. Heinz's Pet Products Co., which makes 9-Lives cat food, tried cuts. It also tried raising prices, and that didn't work either. The company finally yanked itself out of the cat food fight by completely rebuilding its business around advantages unique to its strategic position. YOU THINK pricing is bad in your business, howl about this: Since 1984 Heinz has had to cut by 22% the price to the retailer of a case of 9-Lives, from $6.77 to $5.25, as competitors Nestle, Quaker, Mars, and Grand Metropolitan tried to scratch each other's market share out. No wonder 9-Lives' Morris gets a little grumpy sometimes. Fed up with the downward spiral, Heinz bucked the trend in 1991 and jacked up prices. ''It was a disaster,'' says Heinz's Pet Products chief Bill Johnson, 45. ''None of our competitors followed suit and our market share dropped precipitously'' -- like from 23% to 15%. That's when Johnson, the confident son of former Cincinnati Bengals coach ''Tiger'' Johnson, realized he had to refigure his business. ''We decided to run pet foods assuming the price war would never end,'' he says. To do so he turned the pricing equation on its head. ''Instead of calculating out what it cost to make cat food and price accordingly, we asked ourselves what did consumers want to pay,'' Johnson explains. His team decided that today's finicky customers would pay between 25 cents and 33 cents per 5 1/2-ounce can, tops. Johnson then went to work rationalizing processes to hit that target. Step one was identifying his company's competitive advantages, to wit, strong brand equity, cheap materials in the form of excess tuna from Heinz's StarKist operations -- which goes into more than 15% of Pet Foods' products -- and some proprietary manufacturing processes. ''Step two,'' says Johnson, ''was a draconian reduction of cost.'' Johnson closed eight plants and centralized operations at the company's factory in Bloomsburg, Pennsylvania, expanded from 250,000 square feet to a million today. Though the plant has a stench that could make a sanitation man blanch, it's highly efficient. Output has climbed from about three million cases annually in 1987 to 65 million. High-speed lines whiz 1,500 cans per minute down the line to where superslicers and choppers work the meat. ''We've taken about 30% of the operating cost out of the process,'' says plant manager Colin Corbett, who's on the prowl to save another 20%. Heinz also integrated vertically and partnered with suppliers. Steel for the cans, which are fabricated in Bloomsburg, comes from a Heinz finishing plant in Weirton, West Virginia. Poultry supplier Tyson has an addition to a processing plant near Richmond dedicated to Heinz. The reframing will boost profits at Heinz's cat food business to $55 million + this year, up from $41 million two years ago, according to Wall Street analysts. Case volume is growing 5% to 6% per year and operating margins have climbed past 13% -- terrific in this industry -- at least a 20% improvement. Market share is above 25% and rising.

Today pricing has stabilized, and while competitors have matched Heinz's prices, few are making good money. One, Alpo, is on the ropes. Says Steve Galbraith, a packaged-goods analyst with Sanford C. Bernstein: ''Heinz now has one of the most profitable pet food operations in the business.'' Today Johnson's operations are a shining star in Heinz's otherwise not-so-stellar portfolio of brands. Says Galbraith: ''Pet food should be a paradigm for the rest of the company.'' You have to be a masochist to work in consumer electronics retailing, where the price wars never end. Neither does the resultant bloodletting. Last year alone Michigan's Highland Superstores, a would-be national chain, collapsed into Chapter 11 and was liquidated. Another national pretender, Silo, was sold to Fretter, a competitor also headquartered in Michigan. Both Fretter and McDuff, which is a part of Tandy Corp., retrenched and shuttered over 20% of their stores. That leaves industry leader Circuit City and upstart Best Buy looking like the last two cars in a demolition derby. Both will survive, but right now Best Buy appears to have the fewest dents. Best Buy's strategy to win the bash? Figure out what customers don't want and eliminate same, along with the accompanying costs. ''We realized that low prices are just a first step, a given, in this business,'' says Best Buy CEO Richard Schulze, 53. ''We knew our prices had to match the discounters', but we also knew we had to offer something different.'' After a round of focus groups and surveys, Schulze pinpointed what customers disliked most about consumer electronics stores. No. 1: pushy, commissioned salespeople steering them to high-margin items. No. 2: multiple checkout points. ''We said, 'OK, we'll get rid of both,' '' says Schulze. Today Best Buy could be called ''Den Depot.'' Its 150-plus stores, which range from 28,000 to 45,000 square feet, are set up like miniwarehouses with merchandise stacked on industrial shelving. Customers load items themselves into oversized shopping carts. Salaried salespeople don't poke or prod -- though they are very available to answer questions -- and the jumbo checkout area looks like a Toys ''R'' Us. Unlike those darkly lit Mr. McCool & stereo shops, Best Buys are bright and ''friendly, like a supermarket,'' says Schulze, a calm, self-made Minnesotan. Almost half of Best Buy customers and salespeople are women. The company is remixing its product lines too, to make itself less of a target in the electronics wars. Whereas four years ago 60% of sales came from consumer electronics, now only 38% do. Today, CDs -- top price $11.99 -- and home office products make up 47% of revenues, both faster growing categories. The result? Best Buy's per store revenue has doubled in three years, to $23 million. Same-store sales climbed 19% last year, and Ursula Moran of Sanford C. Bernstein looks for annual earnings gains of over 20% for the next four years. Best Buy stores average more than 500 transactions a day at $115, vs. about 190 per day at $250 for Circuit City. Simple math. Circuit City, long the industry leader, does have some numbers in its favor: a gross margin near 27%, or more than ten percentage points higher than Best Buy's. But that gross is under siege in cities like Atlanta, where Best Buy recently opened six stores, forcing Circuit to lower prices. Circuit City's net margins have been falling while Best Buy's have been climbing. ''Competing on price ultimately gets you nowhere,'' says Schulze. ''You can say you're cheaper, but cheaper than whom, and for how long?'' THAT'S EXACTLY the problem for mortgage bankers.They sell money -- what else could matter in that category except price? It's no wonder then that their business is almost constantly in a state of warfare, particularly when rates head up and demand slows. The last clear-out in the late 1980s knocked out or badly clipped nearly every company in the industry -- Commonwealth Mortgage and Citifed Financial, for example. Another fire sale may be at hand. Though mortgage origination hit a record $1 trillion last year, rising rates will probably keep volume under $800 billion this year. Price competition is already heating up and margins are contracting. Yet Arbor National Mortgage, a midsize company in Uniondale, New York, will likely have another banner year. ''We never sell products based on price,'' says Nancy Boles, Arbor's senior vice president of marketing. ''We focus on niche products, repackaging plain-vanilla mortgages, and relationships with the community.'' Differentiation in mortgages? Sure. For instance, Arbor will lend to consumers with poor credit ratings. But unlike competitors such as the Money Store or Champion, which price their products assuming a high default rate, Arbor does extensive appraisal work on potential customers' finances, and as a result suffers fewer losses. Another tactic: Arbor takes a standard Fannie Mae mortgage and repackages it into the Arbor Home Bridal Registry. Couples register with Arbor instead of a department store so friends and families can contribute to the newlyweds' first home. ''Running the registry is a lot of work, so we aren't as concerned with getting couples to register as we are in getting inquiries about purchasing a first home,'' says Boles. ''Only three dozen couples have actually registered, but we've had over 5,000 couples call to ask about the service. Their names are now in our database. We hope to have them as customers someday.'' Arbor also holds mortgage seminars for real estate brokers, accountants, and consumers. And the company plants a tree for customers who want one, either in their yard or in a public forest. Sensitivity is smart marketing. Arbor's revenues have jumped over threefold since 1991, to $60 million. Net income has climbed even more, to $7.7 million last year, and Wall Street analysts look for $12 million this year. The delinquency ratio is 1.8%, one of the lowest in the business. Says Gareth Plank, a mortgage banking analyst with Mabon Securities: ''Arbor excels at staying above the fray.'' Drive 90 miles north out of Atlanta to Dalton, Georgia, where 80% of the nation's carpet is made, and ask Robert Shaw, 62, CEO of Shaw Industries, about pricing. ''The carpet business has been overexpanded for a decade,'' he drawls. ''Prices have been dropping for years.'' Carpet wholesales today for about $5.90 a yard, down from $6.40 in 1989. All the more amazing that Shaw's profits have grown from $22 million, to $100 million, in a decade. How'd he do that? The answer is domination. Shaw loves gaining market share almost as much as he loves golf, and he's built his own golf course. His motto might be: ''Control enough of the market and you can ride out the roughest times. Grow big enough so that your costs fall, and pricing be damned.'' Since 1984, Shaw has expanded his market share from less than 5% to over 30% today and growing. In the all-important builders' residential segment he's above 40%. By investing in new technologies and constantly refitting his plants, Shaw has made inefficient foes pay the ultimate price. When competitors like Salem Carpets and the carpet divisions of West Point-Pepperell and Armstrong World didn't match him, he bought them. The incremental share begat economies of scale, which begat fatter operating margins -- 8.5% pretax, just about the best in the business. Only three large players remain: Shaw, Mohawk Industries, and the private Beaulieu Group. Shaw is now twice the size of Mohawk, its nearest domestic competitor. Shaw is turning to increased vertical integration to gain even more control of his destiny. ''We want to be involved with as much of the process of making and selling carpet as is practical,'' he says. ''That way we're in charge of costs.'' The company expanded its polypropylene extrusion capacity so that it now produces 25% of the fiber it uses to make carpet. On the consumer end of the product, Shaw just launched a program to brand lines of carpet. Branding is, of course, a classic way to turn away from competition on price. In fact, competitor Mohawk is similarly attempting to market its MBA line of carpet. Shaw's Trustmark program requires carpet retailers to commit 50% of their floor space and pay $22,000 for the initial privilege, and then $7,000 in annual fees. In return, Shaw spends $30 million on a national ad campaign, plus in-store displays and promotion, training, sales, and financing help. Shaw hopes to attract consumers to Trustmark with clear, easy-to-read labels that translate carpetese like twist, face weight, and density into English. The labels also rate the quality of the rug. Shaw's plan is simple: become the dominant brand in the minds of retailers and consumers. Says textile analyst John Baugh with Wheat First in Richmond: ''They say loyalty in this business is about a penny a yard. Shaw may just change that.'' AS ALWAYS, one way to exit a price war is to innovate. Take Becton Dickinson's hypodermic needles. The company produces over a billion each year, at a paltry dime apiece worth over $100 million in sales. Prices have been flat to down over the past decade. During one particularly painful period in the late 1980s, a Japanese competitor began selling its wares for 7 cents a unit. In other words, you wouldn't want to be stuck in the needle business. Then Becton Dickinson got together with Baxter International, which had developed InterLink, a needleless needle. The point to remember is that the needles doctors stick in your arm account for about 50% of the market. The other half are used to hook up intravenous lines to other IVs, which is where the Baxter-Becton team made its mark. InterLink looks like a regular syringe except the needle is replaced by a hard piece of tapered plastic tubing that ends in a blunt tip. Baxter created a new type of plastic-and-rubber seal that could be punctured and then would reseal around such a plastic spike. Baxter asked Becton to produce the spike. Hospitals gladly pay more for InterLink because the pointless needles lower the risk of accidental needle sticks. Last year health care workers reported about one million sticks, costing hospitals upwards of $400 per incident in lost time and paperwork, excluding any legal or long-term health costs. ''That's the attraction,'' says Gary Cohen, a marketing VP with Becton Dickinson. ''Even though InterLink needles cost about 25 cents, hospitals save money.'' InterLink sales revenues could exceed Becton Dickinson's traditional needle sales this year, with only 30% of the domestic market tapped and the overseas markets still to conquer. The company's needle division, once puttering along with low single-digit growth, is now bounding ahead in the low double digits and gaining market share on rival American Home Products. No business has more rampant price competition than computers. The price of an average personal computer has declined from about $5,000 in 1984 to less than $2,000 today and is still dropping. If you're a consumer, clap your hands. If you're a manufacturer, weep. So what's a PC maker to do? In supercompetitive industries, carving out an impenetrable niche is a matter of life or death. One of the breathing: Tri- Star Computer, a private company in Phoenix making CAD workstations. Tri- Star positions its $4,000 machines underneath the $20,000 workstations sold by Sun, IBM, and Apple, but above generic, toaster-oven PCs. Originally a maker of general-purpose high-performance machines, Tri-Star noticed that most were bought by architects and engineers, so it filled in that niche. Tri-Star delivers value to power users by buying more high-end components than the big boys, so it gets a price break on more sophisticated parts. The company passes those savings on to customers. Tri-Star always includes high-end features as standard. When most PC makers offer a 14-inch monitor, Tri-Star sells a 17-incher. ''With a price break we could sell it for only $400 more than the 14-inch one; our competitors price it at $800 more,'' says Mike Martin, Tri-Star's head of marketing. . ''We occupy a slice of the market that's too small for the big boys,'' says Martin. ''Plus we're too nimble. We keep our inventory small so we can continuously upgrade our machines.'' It's dangerous territory. Just like in real-life battles, losers in price wars sometimes perish. ''It's treacherous all right,'' says Martin. ''We recently watched four competitors just in the Phoenix area go out of business.'' It doesn't seem that long ago when companies prided themselves on having the highest prices in their category. A high price carried cachet. Now it's often a liability, a target. Just ask BMW or American Express or MGM Grand Air. Look for the pressure to continue. Consumers demand it, and even an improving U.S. economy will not be of much help. Because somewhere out there a competitor is going to want your market share in the worst way. But remember, there is no worse way to respond than to go to war. Think bigger, think differently.

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART/SOURCE: MCKINSEY & CO. CAPTION: THE PERILS OF A PRICE CUT PROFIT FALLS BY 37% An innocent little 3% price cut by the average S&P 1,000 company knocks profits down from 8.1% to 5.1% -- a whopping 37%.

CHART: NOT AVAILABLE CREDIT: FORTUNE TABLE CAPTION: LATEST REPORTS FROM THE PRICE FRONT