Strategic Positioning and Value Creation

Question 1

Entry Deterrence

Answer 1

Entry deterring strategies e.g. limit pricing, predatory pricing, capacity expansion, bundling

Question 2

For entry deterring strategies to work…

Answer 2

Incumbent must earn higher profits as a monopolist than as a duopolist, and

Strategy should change entrants’ expectations regarding post-entry competition

Question 3

When to rethink entry deterrent strategy use:

Answer 3

Contestable market i.e. possibility of ‘hit and run’ entry (zero sunk cost)

• Drives monopolist to set price at competitive levels (Perfectly contestable)

Question 4

Limit Pricing

Answer 4

Incumbent sets low price to discourage entrants

Question 5

Two forms of limit pricing

Answer 5

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

Question 6

Is limit pricing rational?

Answer 6

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 7

Predatory Pricing

Answer 7

Incumbent sets price < SRMC but expects to recoup losses when rival exits

Question 8

Is Predatory Pricing rational

Answer 8

! (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 9

Dual Uncertainty

Answer 9

! 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!

Question 10

Reputation

Answer 10

• 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 11

Entry-Deterrence: Excess Capacity

Answer 11

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

Question 12

Entry- Deterrence: Strategic Bundling

Answer 12

Typology:
• Bundle form
• Bundle focus

Question 13

Judo Economics

Answer 13

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.

Question 14

Positioning and Advantage

Answer 14

! 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

Question 15

Competitive advantage (traditional):

Answer 15

• 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

Question 16

Competitive advantage (value-based):

Answer 16

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’

Question 17

Value Creation

Answer 17

• 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)

Question 18

Strategy Statement:

Answer 18

To compete successfully firms need to deliver largest consumer surplus

Question 19

Value Creation

formula

Answer 19

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

Question 20

Value Creation strategy

Answer 20

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!

Question 21

Porter’s Generic Strategies

Answer 21

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