Lecture Unit 5: Market Entry (2/2)

Question 1

What are entry deterring strategies?

Answer 1

= strategies or predatory acts that the incumbent can engage in to actively deter entry

Question 2

What is needed so that entry-deterring strategies work? (From a profitable perspective of the incumbent)

Answer 2

• 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

Question 3

What are examples of entry deterring strategies?

Answer 3

• limit pricing
• predatory pricing
• strategic bundling

Question 4

What is a contestable market? When is a market perfect contestable?

Answer 4

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

Question 5

What will an incumbent do that uses the limit pricing entry-detering strategy?

Answer 5

Incumbent will set the price sufficiently low to discourage entrants

Question 6

Is the limit pricing strategy rational?

Answer 6

• 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

Question 7

What does an incumbent do in predatory pricing as an entry-detering strategy?

Answer 7

large incumbent sets a low price to drive smaller rivals from the market

Question 8

What is the purpose of predatory pricing as entry-detering strategy?

Answer 8

Purpose:

• Drive out current rivals and make future rivals think twice about entry
• Make rivals rethink the potential of potential for post-entry profit

Question 9

What is the intuition of the incumbent engaging in predatory pricing? ( what are they hoping for)

Answer 9

• The predatory incumbent expects the losses it incurs while
• driving competitors from the market can be made up later through monopoly profits

Question 10

Is predatory pricing rational?

Answer 10

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

Question 11

What is the chain store paradox?

Answer 11

= many firms engage in predatory pricing even when it is irrational

Question 12

When is predatory pricing rational under game theoretic models?

Answer 12

= game theoretic models that include uncertainty and information asymmenty

–>show that prediction can be a rational strategy

Question 13

When are limit pricing and predatory pricing rational?

Answer 13

• 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

Question 14

When can predatory pricing deter entry?

Answer 14

= Predatory pricing can deter entry when the incumbent seeks a reputation for toughness

Question 15

How can a incumbent have a tough repution?

Answer 15

-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)

Question 16

What may happen if the incumbent does not slash prices? (predatory pricing)

Answer 16

If the incumbent does not slash prices, other challengers may consider him easy’ rather than tough

Question 17

What happens to well-known firms after their rivals disappear?

Answer 17

Some well-known firms enjoy a reputation for toughness after their rivals disappear.

Question 18

How can predatory pricing lead to “war of attrition”?

Answer 18

• 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

Question 19

Which firms are well positioned to engage in a price war?

Answer 19

Firms that face exit barriers are well positioned to engage in a price war.

Question 20

What can a firm do to deter its rivals in a price war?

Answer 20

A firm can try to convince its rivals that it can outlast them.

Question 21

How might the winner of a price war be affected compared to no price war (predatory pricing & war of attrition)

Answer 21

Even the winner may be worse off compared to not having had the price war at all.

Question 22

When is predatory pricing only possible to deter entry? (Capacity and entry deterrence)

Answer 22

= Predatory pricing can only deter entry if the predator has the capacity to meet the increasing customer demand

Question 23

When does excess capacity work to deter entry? (excess capacity need for predatory pricing)

Answer 23

• 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

Question 24

When does bundling occur?

Answer 24

= 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

Question 25

What is strategic bundling?

Answer 25

Strategic bundling **gives consumers** **little** **choice** but to **buy** the e**ntire bundle** from the incumbent

Question 26

What does the evidence say about firms pursuing entry-deterring strategies?

Answer 26

There is **only little systematic evidenc**e on firms **pursuing** **entry**-deterring strategies.

Question 27

"What did Robert Smiley's survey on entry-deterring strategies reveal about product managers' use of these strategies?" **When do they use them ?**

Answer 27

- **Managers** **rely** much **more** on strategies that **increase entry costs** than - on strategies that **affect the entrant's perception** about **post**-entry competition

Question 28

What are the items on the entry-deterrence checkliist?

Answer 28

- sunk costs - production barriers - reputation - switching costs - tie up access - limit pricing - predatory pricing

Question 29

When are switching costs most effective as an entry-deterrence strategy?

Answer 29

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?

Question 30

When is tying up access most effective as an entry-deterrence strategy?

Answer 30

**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.

Question 31

When is limit pricing most effective as an entry-deterrence strategy?

Answer 31

Limit pricing is **most effectiv**e when **entrants** are **unsure** about **demand and/or costs.** **Comment**: May require permanent reduction in profit margins to sustain entry deterrence.

Question 32

When can is **predatory pricing** most effective as an **entry- deterring strategy** (checklist)

Answer 32

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.

Question 33

When are sunk costs most effective as an entry-deterrence strategy?

Answer 33

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

Question 34

When are **production barriers most effective** as an **entry-deterrence strategy**? (Checklist)

Answer 34

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.

Question 35

When is **reputation most effective** as an **entry-deterrence strategy?** (checklist)

Answer 35

Reputation is **most effectiv**e when **incumbents** have l**ongstanding 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.

Question 36

When is the judo economics used ?

Answer 36

strategy used when **starting** a company **in a sector dominated** by a **large competitor**

Question 37

What does the judo business strategy say?

Answer 37

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 advantag**e of **changes** in the market