Market Dynamics and Innovation Flashcards
Entrants
firms produce & sell in new markets
Entry threatens incumbents:
Reduced market share
• Intensified price competition
Forms of Entry
New firm
• Established firm diversifying into new product/market
Forms of exit:
Firm closes e.g. Stardot
• Discontinue product line
• Leave geographical market e.g. Ikea Coventry
Conclusions for managers:
- When planning for future, account for entry by (as yet) unknown future competitors…but, be cautious (firm type)!
- May need capital for growth as survival and growth of new entrants coincide
- Be aware of entry and exit conditions of your sector and how they change (time).
The (Trade-off) Decision:
sunk cost of entry vs. present value of the postentry profit stream
Sunk costs of entry
investment in specialised assets, obtaining government licenses etc.
Postentry profit
depend on demand and cost conditions and form of competition
Barriers to Entry
• Function?
Allow incumbents to earn economic profit
• Make it unprofitable for new firms to enter
Structural barriers (natural advantages):
Costs or Marketing advantages
• Protection by regulations etc.
Strategic barriers (incumbents’ actions):
Pricing strategies e.g. predatory or limit pricing
• Change capacity e.g. create excess
• Bundling of products
Types of Entry Conditions
Blockaded:
• High structural/Low postentry profits e.g. energy markets
- Accommodated:
- Low structural/Entry-deterring strategies ineffective (cost>benefits to incumbent) e.g. rapid technology developments esp in services
• Deterred:
Entry-deterring strategies effective and increase incumbent’s profits
What is the strategic distinction between an incumbent and new entrant? (Relativity and Contingency)
○ Incumbent’s sunk cost (i.e. non-recoverable) is new entrant’s incremental cost
○ Established relationships with customers and suppliers not easy to replicate (takes time)
○ Exploiting learning curve effects (economies)
○ Switching costs for customers=disincentive?
Barriers to Exit
Sunk costs reduce marginal cost of incumbency (vs alternative)
• ! Obligations and commitments to suppliers/employees also sunk costs
• ! Relationship-specific assets may (will?) have low resale value
• ! Government regulations can also be a barrier to exit
Entry Deterrence
Entry deterring strategies e.g. limit pricing, predatory pricing, capacity expansion, bundling
For these strategies to work
- Incumbent must earn higher profits as a monopolist than as a duopolist, and
- Strategy should change entrants’ expectations regarding post-entry competition
When to rethink entry deterrent use:
Contestable market i.e. possibility of ‘hit and run’ entry (zero sunk cost)
• Drives monopolist to set price at competitive levels (Perfectly contestable)
Limit Pricing
! Incumbent sets low price to discourage entrants
May mean sacrifice of profits and/or inability to meet market demand
Two forms of limit pricing
Contestable limit pricing:
• Excess capacity and P < MC(entrant)
• Credibly meet market demand at low price
Strategic limit pricing
• Limited capacity or rising marginal costs
Is limit pricing rational?
Multiple periods -> low price forever!
! Better off as Cournot duopolist? ! Even in t=2, not SPNE
! Potential entrants can rationally anticipate that the post-entry price will not be less than the Cournot equilibrium price (See: Fig 6.3 p.198 for the maths!)
Predatory Pricing
Incumbent sets price < SRMC but expects to recoup losses when rival exits
Reverse induction) if all entrants can perfectly foresee future course of incumbent’s pricing = failure!
Chain store paradox:
Firms do engage in predatory pricing even when irrational to expect to deter entry
Is predatory Pricing Rational
(Reverse induction) if all entrants can perfectly foresee future course of incumbent’s pricing = failure!
! Chain store paradox: - Firms do engage in predatory pricing even when irrational to expect to deter entry
! Why?
Irrational behaviour or Incorrect theory or Incomplete Models (uncertainty and asymmetrical information)?
Dual Uncertainty
Entrant uncertain about incumbent’s cost as well as the level of demand.
Entrants’ rationale:
Incumbent pricing below monopoly price regardless of cost = motivation?
! Infers demand is low or incumbent’s costs too low (structural)
! Either way, entry is deterred!
Reputation
• Predatory pricing can deter entry when the incumbent seeks a reputation for toughness
If incumbent doesn’t slash prices, other challengers may consider firm ‘easy’ rather than ‘tough’
• War of Attrition (price war)
Entry-Deterrence: Excess Capacity
Drivers:
• Internal via ‘lumpy’ capital increments
• Influenced by variations in economic activity (demand)
Strategic Impact:
• Credibility of predatory pricing
• Fend-off potential entrants when certainty
Entry- Deterrence: Strategic Bundling
• Typology:
○ • Bundle form
○ • Bundle focus
• Example: Alfons and Nina (2020) EVs, batteries and SPVs
Judo Economics
Use opponent’s strength to one’s advantage.
• ! Entrant discourages the incumbent from entry deterrence strategies by appearing to be a non-threat in the long term
• ! Incurring large losses may not appear worthwhile to the incumbent.
!Example? Innovation
