(FORTUNE Magazine) – As Bob Barker's announcer would say, "Come on down." More and more companies are heeding that call by slashing prices to the bone. That's great for consumers--but potentially chilling for investors. Under the right circumstances, such cuts can be a smart move--a way to bump up market share and increase revenues. But when managed poorly, price cuts can permanently damage a company's bottom line--and its stock price. The key is recognizing the difference between a good trimming strategy and a bad one.

In the short run, no one benefits from a price war. "It's not a question of who wins, it's a matter of who gets hurt the least," says Craig Zawada, a pricing specialist at McKinsey & Co. Indeed, according to a McKinsey analysis of FORTUNE 1,000 companies, a 1% price cut--assuming no change in volume or costs--lowers operating earnings by an average of 8%.

Witness the havoc price wars have wreaked on technology companies. Dell, for instance, has cut personal computer prices by as much as 20% in an effort to gain market share. In April, Dell passed Compaq as the No. 1 global seller of PCs for the first time. But victory has been costly--Dell's gross margins have slipped from 21% to 18%, despite a big jump in unit sales and a reduction in Dell's costs.

Intel, meanwhile, has slashed the bill for its Pentium 4 chips by as much as 50% as it tries to regain market share lost to rival Advanced Micro Devices. The company now expects 2001 gross margins of just 50%, down from 63% last year.

Brutal consequences, but for some companies aggressive pricing is the best option. "Eventually Dell will kill the other competitors, because they are the low-cost manufacturer," says Lehman Brothers technology analyst Dan Niles. As for Intel, "They have no choice," Niles says. "They aren't able to just innovate their way out of this."

The same could be said for Duracell, Gillette's battery division. Energizer and Rayovac are grabbing customers from Duracell, cutting into Gillette's revenues and profits. But the company has so far resisted steep cuts at the register. Instead, it's pumping $100 million into advertising and marketing. Andrew Shore, an analyst at Deutsche Banc Alex. Brown, contends that's not enough. "It's going to be [Gillette CEO] Jim Kilts' undoing if he believes the issue is something much broader than just pricing," Shore says. He figures there's a "70% chance" that Duracell will end up cutting prices, a move that would be far less damaging to Gillette's profits than to those of its undiversified competitors. A 10% cut in prices, Shore estimates, would trim 2% from Gillette's earnings--but matching the cuts would whack 20% to 30% from those of Rayovac and Energizer. "Sometimes you just have to go after the cash flow and the profit stream of your competitors," he says. "You've got to put a whuppin' to them."

To ensure that investors don't get whupped, McKinsey's Zawada suggests examining the following. First, any company launching a price war should have a cost or technological advantage over its competitors--as is the case with Dell and Intel. Price cuts also make sense, he says, if there is pent-up demand for a product: For instance, sales of microwaves skyrocketed when the price dropped below $100. And cuts can work if confined to specific products or customers (as with airline tickets), hurting only a sliver of earnings. "If one or more of these things is not in place, I would really question the price cut," says Zawada.

As for the investors in Dell and Intel--and potentially Gillette--the bottom line is this: Earnings won't be pretty, and margins may never return to their former glory. Over the long haul, though, these companies have what it takes to win price battles. That may not be true for their competitors: There could be hell to pay.

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