Market Dynamics and Innovation

Question 1

Entrants

Answer 1

firms produce & sell in new markets

Question 2

Entry threatens incumbents:

Answer 2

Reduced market share

• Intensified price competition

Question 3

Forms of Entry

Answer 3

New firm

• Established firm diversifying into new product/market

Question 4

Forms of exit:

Answer 4

Firm closes e.g. Stardot
• Discontinue product line
• Leave geographical market e.g. Ikea Coventry

Question 5

Conclusions for managers:

Answer 5

• 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).

Question 6

The (Trade-off) Decision:

Answer 6

sunk cost of entry vs. present value of the postentry profit stream

Question 7

Sunk costs of entry

Answer 7

investment in specialised assets, obtaining government licenses etc.

Question 8

Postentry profit

Answer 8

depend on demand and cost conditions and form of competition

Question 9

Barriers to Entry

• Function?

Answer 9

Allow incumbents to earn economic profit

• Make it unprofitable for new firms to enter

Question 10

Structural barriers (natural advantages):

Answer 10

Costs or Marketing advantages

• Protection by regulations etc.

Question 11

Strategic barriers (incumbents’ actions):

Answer 11

Pricing strategies e.g. predatory or limit pricing
• Change capacity e.g. create excess
• Bundling of products

Question 12

Types of Entry Conditions

Answer 12

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

Question 13

What is the strategic distinction between an incumbent and new entrant? (Relativity and Contingency)

Answer 13

○ 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?

Question 14

Barriers to Exit

Answer 14

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

Question 15

Entry Deterrence

Answer 15

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

Question 16

When to rethink entry deterrent use:

Answer 16

Contestable market i.e. possibility of ‘hit and run’ entry (zero sunk cost)
• Drives monopolist to set price at competitive levels (Perfectly contestable)

Question 17

Limit Pricing

Answer 17

! Incumbent sets low price to discourage entrants

May mean sacrifice of profits and/or inability to meet market demand

Question 18

Two forms of limit pricing

Answer 18

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

Question 19

Is limit pricing rational?

Answer 19

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!)

Question 20

Predatory Pricing

Answer 20

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!

Question 21

Chain store paradox:

Answer 21

Firms do engage in predatory pricing even when irrational to expect to deter entry

Question 22

Is predatory Pricing Rational

Answer 22

(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)?

Question 23

Dual Uncertainty

Answer 23

Entrant uncertain about incumbent’s cost as well as the level of demand.

Question 24

Entrants’ rationale:

Answer 24

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!

Question 25

Reputation

Answer 25

• 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)

Question 26

Entry-Deterrence: Excess Capacity

Answer 26

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

Question 27

Entry- Deterrence: Strategic Bundling

Answer 27

• Typology:
○ • Bundle form
○ • Bundle focus
• Example: Alfons and Nina (2020) EVs, batteries and SPVs

Question 28

Judo Economics

Answer 28

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