Advanced topics in Business Strategy Flashcards
How can firms try and limit the number of competitors they face in a market?
- Limit Pricing
- Predatory Pricing
- Raising rival’s costs
- Price Discrimination
How can firms change the business environment to try and maximise profit?
By changing the timing of decision, or the order of the moves.
What is limit pricing?
Where a firm maintains a price below the monopoly level to prevent entry into the market. Note: may not be profitable, so managers need to set this lower price carefully!
Why can limit pricing fail?
The incumbent could continue to charge monopoly prices, but threaten to expand production if entry occurred. This would not work, because a rational entrant would know this threat was not credible and hence would continue to enter the market.
What conditions help the effectiveness of limit pricing?
The pre-entry price of the incumbent must reflect its post-entry profits. This can be done through:
- Commitment mechanisms
- Learning curve effects
- Incomplete information
- Reputation effects
What are commitment mechanisms?
A firm may commit to buying a factory that can produce no less than a high level of post-entry output. (consider the game theory tree).
What are learning curve effects?
Incumbent firms can, in the first period produce more than the monopoly output. The experience gained in producing this higher level output, means that the firm can produce this output at a lower cost in future. Since output is higher, profits are lower. Hence, the fact that pre-entry price is linked with post-entry profits makes limit pricing successful.
How does incomplete info relate to limit pricing?
For entrepreneurs, there is a cost involved in identifying new profitable business opportunities. If firms can “hide” information about the profitability of their business, then this cost increases.
What are reputation effects?
If entry isn’t stopped early, then entry in the future may be encouraged. Hence, it may benefit a firm to appear tough on entrants, to increase profits in the long run.
When is limit pricing profitable?
Obviously, when the profits under limit pricing is greater than the profits gained under a duopoly (Show this algebraically)!
When is limit pricing attractive?
- When the interest rate is low.
- When monopoly prices and the duopoly prices are similar
- When duopoly profits are much lower than limit-price profits.
What is predatory pricing?
Where firms charge a price below it’s MC to drive existing competitors from the market. It involves a trade off between the initial losses, and the future higher profits gained by driving others out. The firm must have the financial resources to maintain the incredibly low price.
What strategies can “prey” firms adopt to try and counter predatory pricing?
- Stop production entirely to make the predator lose more money.
- Purchase and stockpile goods from the predator, and sell them back on at a later date.
Note: Predatory pricing is often costly for the predator. It generally only works in removing small firms, not firms that are equal in size to the predator.
What are the tactics firms can use to raise rival’s costs?
- MC: By raising a rival firms MC, it’s reaction function shifts downwards (i.e. it should produce less that it previously would, for a given q1). This allows firm 1 to produce on a lower isoprofit curve, and hence achieve higher profits.
- FC: The incumbent can lobby for legislation that would raise the FC of the potential entrant. This means that the entrant must either: enter and make a loss, or not enter and make zero profit. Hence it will not enter. (show with game tree)
How does price discrimination effect the effectiveness of these strategies?
Price discrimination can make predatory and limit pricing more effective.
- Firms can only cut prices for certain sections of the market (those that will inflict the most damage to competitors / potential entrants)
- Also reduces the negative effects associated with these strategies
