Lecture Unit 6: Dynamic competition across time (3/3) Flashcards
What are impediments to coordination?
- The Misread Problem
- Lumpiness of orders
- Information availability regarding sales transaction
- Volatility of demand conditions
- Asymmetries among firms
What happens when it is possible to misread a rival’s move in a tit-for-tat strategy? (Performance)
tit-for-tat may not perform as well as more forgiving strategies
What are two scenarios where misread can happen?
(Impediments to coordination)
1. firm mistakenly believes a competitor is changing one price when it is really charging another
- A firm may be able to observe the rival’s list price but not the effective price;
2. firm misunderstands the reasons for a competitor’s pricing decision or the own change in market share.
- A drop in the list price may be read as a price cut when effectively it may not be one
What can a single and additional misread lead a firm to do?
(the Misread probelm)
will lead the firm to alternate between cooperative and non-cooperative moves.
Additional misreads can make the pattern of moves even worse.
What is the effect of additional misreads?
Additional misreads can make the pattern of moves even worse.
Which response might be better when there is a possibility of misreads?
Deferred response may be better than immediate response.
When are orders considered “lumpy”?
Name industry examples!!
(2nd impediment to coordination)
- when sales occur relatively infrequently in large batches as opposed to being smoothly distributed over the year
Examples: airframe manufacturing, ship building
- The lag between orders makes the gain from price cutting more valuable relative to the cost imposed by the rival’s retaliation
What happens to the frequency of competitive interactions when orders are lumpy?
(2nd impediments to coordination)
The frequency of competitive interactions is reduced.
How does the lag between orders affect the gain from price cutting?
The lag between orders makes the gain from price cutting more valuable relative to the cost imposed by the rival’s retaliation.
When can one easier detect deviations from cooperative pricing? Name example
–>Information availability regarding sales transaction –>(Impediments to coordination)
easier to detect when the transactions are public than when they are private
Example: transaction prices for gasoline sales are easily observable while they are not easily observable for automobile sales
–>Information availability regarding sales transaction
When can one harder detect deviations from cooperative pricing? Name example
are harder to detect when the products are custom made than when they are standardized
How do complex transactions affect the likelihood of misreading?
(Availability of information about sales transactions ->impediments to coordination)
Complex transactions may make misreadings more likely compared with simple transactions
(Volatitiy of demand conditions 3thrd impediments to coodrination)
When is price cutting harder to detect?
- when demand conditions are volatile
- and the firm can observe only its own volume of sales
(Volatitiy of demand conditions 3thrd impediments to coodrination)
In which situtation may a firm misread an situation to be an effort to steal busssines?
- Suppose one firm cuts its price in response to a decline in demand
- If other firms see the price cut but cannot detect their rival’s volume reduction, they may misread the situation as an effort to steal business
What might happen if one firm cuts its price in response to a decline in demand?
(Volatility of demand)
- Other firms may see the price cut but cannot detect their rival’s volume reduction,
- leading them to misread the situation as an effort to steal business.
(Volatitiy of demand conditions 3thrd impediments to coodrination)
What makes the coordination difficult? ( costs]
With large fixed costs, the monopoly price fluctuates a lot making coordination difficult
Volatiliy of demand
What impact do large fixed costs have on monopoly pricing?
Large fixed costs cause the monopoly price to fluctuate a lot, making coordination difficult.
What can be a focal point when firms are identical?
A single monopoly price.
Why is it difficult for firms to coordinate pricing strategies?
(assymmetries among firms, sustianabiltiy of cooperative prices)
- Firms usually differ in costs, capacities, etc., which makes it difficult for them to coordinate pricing strategies to common objectives.
Why might small firms have incentives to deviate from an agreement pricing strategy?
- Larger firms often have weak incentives to punish smaller price cutters
- Small firms might induce customers to buy their products by cutting prices.
Coordination in practice
What factors help with coordination among competitors in a market?
- using round number price points
- maintaining even splits of the market shares
- Fewer identical products also make coordination easier
- established conventions and traditions can make rivals’ intentions transparent, aiding in coordination efforts
Coordination in practice
When is coordination easier among products? (in terms of products
Coordination is easier with fewer products that are identical.
Coordination in practice
When is coordination likely to be difficult? (Competitive environment)
in a competitive environments that are turbulent and rapidly changing
(Coordination problem)
What does the folk theorem suggest about cooperative pricing?
- The folk theorem implies that cooperative pricing behavior is a possible outcome in an oligopolistic industry, even if all firms act unilaterally (self-interest)
What is the coordination problem in achieving a desirable equilibrium?
Achieving a desirable equilibrium out of many possible equilibria is a coordination problem.
What must each firm in an oligopolistic industry do according to the folk theorem?
(Coordination problem)
- Each firm must adopt the tit-for-tat strategy without explicit comm-unication that it intends to do so
- this must be a focal point — a strategy so compelling that a firm would expect all other firms to adopt it
What is necessary for a cooperation-inducing strategy to be effective? (According to the folk theorem)
What is this focal point?
- The strategy must be a focal point
- a strategy so compelling that a firm would expect all other firms to adopt it
What are certain markect structure conditions on which achieving a cooerpative pricing depends upon?
cooperative pricing may depend on following conditions
- concentration
- conditions that affect reaction speeds and detection lags
- asymmetries among firms
- price sensitivity of buyers
Where is cooperative pricing more likely to happen? (Terms of market structure ?)
- In concentrated markets
- here revenue loss from a price cut is larger and the potential gain from new customers is smaller
Why is cooperative pricing more likely in concentrated markets?
- Because the revenue loss from a price cut is larger and the potential gain from new customers is smaller.
How can firms facilitate cooperative pricing?
through a number of practicess, including:
- Price leadership
- Advance announcement of price changes
- Most favored customer clauses
- Uniform delivered pricing
What is price leadership? (A way too)
= is a way to overcome the problem of coordinating on a focal equilibrium
What happens in price leadership? (What do firms give up)
- Each firm gives up its pricing autonomy and cedes control over industry pricing to a single firm
How does the price leader influence the industry?
Name example of a low-price leader
- The price leader in the industry announces price changes ahead of others,
- and others match the leader’s price.
Example: low-price leader: Walmart
When can the system of price leadership break down?
The system can break down if the leader does not retaliate if one of the follower firms defects
What does advance announcement of price changes do?
It reduces the uncertainty that the rival will *undercut the firm
What is another benefit of advance announcement of price changes?
It allows firms to roll back the changes if the rival deviates from cooperative pricing.
hat is a most favored customer clause?
= is a provision in a sales contract that promises a buyer the lowest price the seller charges
What are the two types of most favored customer policies mentioned?
- contemporaneous most favored customer policy; customer receives same terms and conditions at the same tiime
- retroactive most favored customer policy; customers receives most favorable deal that were offered to any customer retroactively
How can most favored customer clauses inhibit/prevent (hindern) price competition?
- Most of them benefit the buyer ( a price cut to any customer lowers the price for the most favored customer),
- They discourage firms from cutting prices to other customers who do not have these clauses because a price cut to any customer lowers the price for the most favored customer
What is uniform delivered pricing?
- A pricing method where transportation costs are included,
- facilitating cooperative pricing by making responses to price cutting more effective and deterrent.
What are the two types of pricing when transportation costs are significant?
- Uniform FOB pricing
- uniform delivered pricing.
Why is uniform delivered pricing effective in deterring defection from cooperative pricing?
Because the response to price cutting can be “surgical” and highly effective (
- any attempt competitors to undercut prices can be met with a precise and effective response since all customers pay the same price, it is easier for companies to react
What affects the sustainability of cooperative pricing?
- market structure affects the sustainability of cooperative pricing
- thus, high market concentration facilitates cooperative pricing
Market structure: concentration, conditions that affect reaction speed and detection lags, asymmetries among firms, price sensitivity of buyers**
What makes pricing cooperation more difficult?
- asymmetries among firms
- lumpy orders
- high buyer concentration
- secret sales transactions
- volatile demand
Which practices facilitate cooperative pricing?
- price leadership
- advance announcements of price changes
- most favored customer clauses
- uniform delivered pricing
Is high market concentration good for cooperative pricing?
Yes, high market concentration facilitates cooperative pricing
