Chapter 12: Entry and Nonpricing Strategies to Deter Entry

Question 1

Excess Capacity

Answer 1

• Incumbent firm can use excess capacity to deter entry credibly because the factory is there
• Models of entry deterrence based on the building of excess capacity are models in which the monopolist moves first and selects a level of capacity, then the potential entrant decides whether to enter, then the monopolist selects a capacity level and output. The potential entrant produces a quantity of zero if it stays out

Question 2

Dominant Firm Competitive Fringe Model - Raising Rivals Costs

Answer 2

• A sufficient condition for a strategy to be profitable is for it to shift up the dominant firm’s residual demand curve by more than it shifts up its average cost curve at the original output (x). In this way, even if the dominant firm were to keep its output constant, the increased price-cost margin would raise its profits. Of course, the predator can generally increase its profits still further by adjusting its output

Question 3

Nonpricing Strategies to Deter Entry: Pre-Emption

Answer 3

• An incumbent who is trying to strategically deter entry can do so by attempting to reduce the entrant’s payoff if it were to enter the market. The expected payoffs are obviously dependent on the amount of customers the entrant expects to have – therefore one way of deterring entry is for the incumbent to “tie up” consumers.
• The strategic creation of brand loyalty can be a barrier to entry – consumers will be less likely to buy the new entrant’s product, as they have no experience of it. Entrants may be forced into expensive price cuts simply to get people to try their product, which will obviously be a deterrent to entry.
• Similarly, if the incumbent has a large advertising budget, any new entrant will potentially have to match this in order to raise awareness of their product and a foothold in the market – a large sunk cost that will prevent some firms entering.

Question 4

Nonpricing Strategies to Deter Entry: Product Proliferation

Answer 4

Product proliferation occurs when organizations market many variations of the same products. This can be done through different colour combinations, product sizes and different product uses. This produces diversity for the firm as it is able to capture its sizable portion of the market.

Ex.) Kellogs, Post, Nabisco, Quaker, General Mills - all produce multiple brands of cereal

Labatt, Molson - 80% of sales (different qualities of beer with different prices)

Question 5

Signalling

Answer 5

• The incumbent firm has an advantage of being the “first mover” and can therefore act in a way that it knows will influence the entrant’s decision. If we assume imperfect knowledge (i.e. the incumbent firm’s costs are only known privately) the entrant can only make assumptions about the incumbent’s cost structure through its price and output levels. Therefore, the incumbent can use these as a signal to any potential entrant.
• One way of using this advantage to deter entry is to charge a price less than the monopoly level. If an entrant is considering entry in a number of similar markets, a low cost incumbent can signal its efficiency to a potential entrant through lowering prices – thereby discouraging what the entrant believes would be unprofitable entry. Signalling needs to be credible to be effective – a low cost firm must be able to show that it can withstand lower profits for an extended period of time, which it would not be able to if it had higher costs.