Lecture Unit 5: Market Entry (2/2) Flashcards
What are entry deterring strategies?
= strategies or predatory acts that the incumbent can engage in to actively deter entry
What is needed so that entry-deterring strategies work? (From a profitable perspective of the incumbent)
- the incumbent must earn higher profits as a monopolist than as a duopolist, and
- the strategy should change the entrants’ expectations regarding post-entry competition
What are examples of entry deterring strategies?
- limit pricing
- predatory pricing
- strategic bundling
What is a contestable market? When is a market perfect contestable?
refers to a market in wich it is possible to have a hit and run entry (zero sunk cost)
–>Perfect contestable market= monopolist sets the price at competitive levels
What will an incumbent do that uses the limit pricing entry-detering strategy?
Incumbent will set the price sufficiently low to discourage entrants
Is the limit pricing strategy rational?
- if multiple periods: incumbent must continuously set a low price in each period to deter entry, which may not be sustainable
- The incumbent may be better off being a Cournot duopolist than limit pricing forever as a monopolist
- Limit pricing equilibrium is not subgame perfect, indicating it’s not a stable strategy
- Potential entrants can rationally anticipate that the post-entry price will not be less than the Cournot equilibrium price
What does an incumbent do in predatory pricing as an entry-detering strategy?
large incumbent sets a low price to drive smaller rivals from the market
What is the purpose of predatory pricing as entry-detering strategy?
Purpose:
- Drive out current rivals and make future rivals think twice about entry
- Make rivals rethink the potential of potential for post-entry profit
What is the intuition of the incumbent engaging in predatory pricing? ( what are they hoping for)
- The predatory incumbent expects the losses it incurs while
- driving competitors from the market can be made up later through monopoly profits
Is predatory pricing rational?
Predatory pricing can be both rational and irrational:
- Irrational: Simple economic models indicate it is irrational if all entrants can perfectly foresee the future course of the incumbent’s pricing
- Rational: Game theoretic models that include uncertainty and information asymmetry show that predation can be a rational strategy
What is the chain store paradox?
= many firms engage in predatory pricing even when it is irrational
When is predatory pricing rational under game theoretic models?
= game theoretic models that include uncertainty and information asymmenty
–>show that prediction can be a rational strategy
When are limit pricing and predatory pricing rational?
- Incumbent wants the entrant to lower its expectations for the post entry price
- Entrant lacks information about incumbent’s costs
- Incumbent’s pricing strategy can alter entrant’s expectation when there is asymmetric information
When can predatory pricing deter entry?
= Predatory pricing can deter entry when the incumbent seeks a reputation for toughness
How can a incumbent have a tough repution?
-incumbent seeks a reputation for toughness by:
- Slashing prices to avoid being perceived as ‘easy’ rather than ‘tough’
- Being ‘tough’ due to low costs (as the incumbent can sustain lower prices for longer periods)
- an irrational desire for market share,
- or there is other competition the entrant is unaware of (which might lead the incumbent to act more aggressively)
What may happen if the incumbent does not slash prices? (predatory pricing)
If the incumbent does not slash prices, other challengers may consider him easy’ rather than tough
What happens to well-known firms after their rivals disappear?
Some well-known firms enjoy a reputation for toughness after their rivals disappear.
How can predatory pricing lead to “war of attrition”?
- If no one leaves in the early stages, a prolonged price war can be bad for all firms in the industry
- The more a firm believes it can outlast its rivals, the more willing it is to stay in the price war
Which firms are well positioned to engage in a price war?
Firms that face exit barriers are well positioned to engage in a price war.
What can a firm do to deter its rivals in a price war?
A firm can try to convince its rivals that it can outlast them.
How might the winner of a price war be affected compared to no price war (predatory pricing & war of attrition)
Even the winner may be worse off compared to not having had the price war at all.
When is predatory pricing only possible to deter entry? (Capacity and entry deterrence)
= Predatory pricing can only deter entry if the predator has the capacity to meet the increasing customer demand
When does excess capacity work to deter entry? (excess capacity need for predatory pricing)
- Incumbent has a sustainable cost advantage
- Market demand growth is slow
- Incumbent cannot back-off from the investment in excess capacity
- Entrant is not the type trying to establish a reputation for toughness
When does bundling occur?
= Bundling occurs when a combination of goods or services is sold at a price that is less than what it would cost to buy the same items separately
What is strategic bundling?
Strategic bundling gives consumers little choice but to buy the entire bundle from the incumbent
What does the evidence say about firms pursuing entry-deterring strategies?
There is only little systematic evidence on firms pursuing entry-deterring strategies.
“What did Robert Smiley’s survey on entry-deterring strategies reveal about product managers’ use of these strategies?” When do they use them ?
- Managers rely much more on strategies that increase entry costs than
- on strategies that affect the entrant’s perception about post-entry competition
What are the items on the entry-deterrence checkliist?
- sunk costs
- production barriers
- reputation
- switching costs
- tie up access
- limit pricing
- predatory pricing
When are switching costs most effective as an entry-deterrence strategy?
Switching costs are most effective when there are few supply-side barriers to entry.
Comment: Can the firm prevent imitation? Do consumers really perceive entrants as different from incumbents?
When is tying up access most effective as an entry-deterrence strategy?
Tying up access is most effective when channels are few and hard to replicate.
_> means securing exclusive or preferential access to critical resources or distribution channels
Comment: Must share spoils with channel. May arouse antitrust scrutiny.
When is limit pricing most effective as an entry-deterrence strategy?
Limit pricing is most effective when entrants are unsure about demand and/or costs.
Comment: May require permanent reduction in profit margins to sustain entry deterrence.
When can is predatory pricing most effective as an entry- deterring strategy (checklist)
when the firm has a reputation for toughness or competes in multiple markets.
Comment:
- Incumbent firm may lose more than the entrant.
- Deep pockets and conviction that there are many potential entrants are a must. May arouse antitrust scrutiny.
When are sunk costs most effective as an entry-deterrence strategy?
Sunk costs are most effective when the incumbent has incurred them and the entrant has not.
Comment: Costs must truly be sunk. If the incumbent can sell fixed assets, then so, too, could an entrant. This implies that failure is not very costly, and entry is harder to deter
When are production barriers most effective as an entry-deterrence strategy? (Checklist)
Production barriers are most effective when
- there are economies of scale or scope
- superior access to critical inputs
- superior location, patents,
- or government subsidies.
Comment: Must be asymmetric (see sunk costs). Technological innovation can cause an abrupt change to the wellbeing of an incumbent. Patents are not all equally defensible, and the cost of defending a patent can be prohibitive.
When is reputation most effective as an entry-deterrence strategy? (checklist)
Reputation is most effective when incumbents have longstanding relationships with suppliers and customers.
Comment: Reputation reflects hard-to-measure factors, such as quality or reliability, that entrants may not be able to promise.
When is the judo economics used ?
strategy used when starting a company in a sector dominated by a large competitor
What does the judo business strategy say?
The Judo Business Strategy:
- speed and agility (i.e. using the smaller size to act quickly and neutralize a larger competitor’s advantages)
- using the competitor’s strengths against it
- anticipating and taking advantage of changes in the market
