Strategic Positioning and Value Creation Flashcards
Entry Deterrence
Entry deterring strategies e.g. limit pricing, predatory pricing, capacity expansion, bundling
For entry deterring 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 strategy 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
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
May mean sacrifice of profits and/or inability to meet market demand
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
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:
- A 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
Empirical research indicates excess capacity across many sectors
- Drivers:
* Internal via ‘lumpy’ capital increments
* Influenced by variations in economic activity (demand) - Strategic Impact:
* Impacts upon credibility of predatory pricing
* Fends-off potential entrants when there is certainty
Entry- Deterrence: Strategic Bundling
Typology:
• Bundle form
• Bundle focus
Judo Economics
Use opponent’s strength for advantage.
- ! Entrant discourages incumbent from entry deterrence strategies by appearing to be non-threat in long term
- ! Relevant? When incurring large losses may not appear worthwhile to the incumbent.
Positioning and Advantage
! Firms in same sector/industry/market can position in different ways
! Not all positions equally profitable or lead to same odds of survival
! Firm’s ability to create value and enjoy a competitive advantage over other firms depends on how it positions itself
Competitive advantage (traditional):
• When firm earns higher rate of economic profit compared to competitors
- Economic profit depends on:
* economic ‘attractiveness’ of market and,
* (economic) value created/captured by firm
Competitive advantage (value-based):
When firm creates more value than competitors (Value Map analysis)
• Enhanced symmetry (co-creation, capture and distribution)
Why Value?
• Brandenburger and Stuart (1996)
• Vertical/Value Chain: Suppliers-Focal Firm-Buyers
• Connect to : Porter’s (internal) ‘Value Chain’
Value Creation
• Brandenburger and Stuart (1996)
○ Symmetry with Suppliers and Buyers
○ Moves beyond traditional IO -> cooperative, bargaining (game theory)
• How is value created?
• Cost position (e.g. LRATC, opportunity cost of doing business and transactions costs)
• Benefit position (e.g. consumers’ wtp)
Strategy Statement:
To compete successfully firms need to deliver largest consumer surplus
Value Creation
formula
B = Maximum willingness to pay (wtp) P = Price of the product (market price) C = Cost of making the product
Value Created (VC) = Consumer Surplus + Producer Surplus VC = (B - P) + (P - C) = B - C
! If B - C (the value created) <0 product not viable.
! If B - C >0 all parties better off because the product was made and sold
Value Creation strategy
Strategy:
• Firms can increase consumer surplus by enhancing perceived benefit or lowering price
• Analysis:
• For different levels of quality, competing firms seen to submit ‘consumer surplus bids’ with price-quality combinations
• If firm fails to offer enough consumer surplus (relative to competitors) -> sales fall!
Porter’s Generic Strategies
Cost Leadership
- Markets where business completes = Broad
- Source of Competitive Advantage = Costs
Cost Focus
- Markets where business completes = Narrow
- Source of Competitive Advantage = Costs
Differentiation Leadership
- Markets where business completes = Broad
- Source of Competitive Advantage = Differentiation
Differentiation Focus
- Markets where business completes = Narrow
- Source of Competitive Advantage = Differentiation
