Transcript Isolating Mechanism

Eko Yulianto
Erika Sugiarto
Entry  Beginning of production and sales by a new firm in
a market
Entry has two effects
– reduced market share
– intensified market competition
Can take two forms
– entry by a new firm (ex. Dreamworks SKG)
– entry by an existing firm diversifying into a new market (ex. Microsoft
entering gaming systems market)
Acquisition is not entry: merely change of identity
Exit  A firm ceases to produce in a market
Exit is the reverse process
Exit could also take different forms
– A firm may simply fold up (Example: PanAm)
– A firm may discontinue a particular product or product group or leave
a particular market (Peugeot leaves the U.S. market)
Dunne, Roberts and Samuelson (DRS): entry and exit in different
industries in the U.S. (1963-1980) found that:
– Entry and exit is pervasive
– Entrants are generally small if they are new
– Most entrants do not survive 10 years, but those that do grow
precipitously.
– Entry and exit rates vary by industry
As part of planning for the future, managers should account for
the unknown future competitors.
Diversifying firms pose a greater threat to the incumbents
since they tend to build bigger plants than other entrants.
Managers of new firms need to find capital for growth since
survival and growth go hand in hand.
Managers should be aware of the entry and exit conditions of
the industry and how these conditions change over time due to
technological changes, regulation and other factors
Barriers to entry are factors that allow the incumbents to earn
economic profit while it is unprofitable for the new firms to enter
the industry.
Barriers to entry can be classified into :
– Structural barriers to entry and
– Strategic barriers to entry
Three entry conditions according to Joe Bain are
– Blockaded entry
 Entry is considered to be blockaded when the incumbent does not need to
take any action to deter entry
– Accommodated entry
 Structural barriers may be low and strategic barriers may be ineffective in deterring
entry or simply not cost effective
– Deterred entry.
 Entry is not blockaded
 Entry deterring strategies are effective in discouraging potential rivals and are cost
effective
 Deterred entry is the only condition under which the incumbents should engage in
predatory acts.
• Asymmetry between incumbent firms and entrants is due
to sunk costs that the incumbent has incurred but the
entrants has not.
• Asymmetries also arise from relationships with
customers and suppliers that can take years to build.
• Asymmetries can also arise when incumbents move
down the learning curve or when it is costly for a
consumer to switch from one seller to another.
The three main types of structural barriers to entry are
–
 Nature may limit the sources of certain inputs and the incumbents may be in
control of these limited sources
 Patents can prevent rivals from imitating a firms products
 Special know how that is hard for the rivals to replicate may be zealously
guarded by the incumbents
–
–
–
If economies of scale are significant, incumbent may face a
high threshold of market share to be profitable.
–
Incumbent’s strategic reaction to entry may further lower price
and cut into entrant’s profits.
–
If entrant succeeds, intense price competition may ensue.
–
Economies of scope in production may exists when multiple
products that share inputs and production technology are
produced in the same plant.
–
Economies of scope in marketing are due to the bulky up
front expenditure an entrant has to incur to achieve
comparable brand awareness as the incumbent’s brand.
–
Incumbent can exploit the brand umbrella (different products
sold under the same brand name) to introduce new products
more easily than new entrants can.
–
The brand umbrella can make it easy for the incumbent to
negotiate the vertical channel (Example: It is easier to get
shelf space with an established brand).
–
Exploitation of the brand name and reputation is not risk-free.
–
If the new product is unsatisfactory, customer dissatisfaction
may harm the image of therest of the brands.
Barriers to exit are factors that make the firm continue producing
under such conditions which would not have encouraged the firm
to enter.
Examples of such barriers are specialized assets labor
agreements, commitment to suppliers and governmental
regulations.
Exit if cannot make an acceptable return on assets
Exit barriers exist
– when there are fixed costs
– when there are relationshipspecific assets
Some examples of entry deterring strategies are limit pricing,
predatory pricing and capacity expansion
For these strategies to work
– Incumbent must earn higher profits as a monopolist than as a
duopolist and
– The strategy should change the entrants’ expectations
regarding post-entry competition (incumbent’s strategies
should be credible)
Contestable Markets and Entry Deterrence
In a perfectly contestable market, a monopolist sets the price at
competitive levels
If there is a possibility of a hit and run entry (zero sunk cost) the
market is contestable
If the market is contestable, it is not worth the monopolist’s while
to adopt entry deterring strategies
An incumbent using the limit pricing strategy will set the price
sufficiently low to discourage entrants
The entrant observes the low price and concludes that the
post entry price will be low as well and decides not to enter
Charge a low price before entry – entrant is put off by the low
price
When multiple periods are considered, the incumbent has to
set the price low in each period to deter entry in the next
period.
Thus, the incumbent never gets to raise the price and does
not reap the benefits of entry Deterrence.
Even in a two period setting, limit pricing equilibrium is not
subgame perfect.
Potential entrants can rationally anticipate that the post-entry
price will not be less than the Cournot equilibrium price.
–
Limit pricing will work if the incumbent has a cost advantage
over the entrant.
–
With a cost advantage, the incumbent can set the price
slightly below entrant’s minimum average cost, ensuring that
entrant can not make profits
–
Limit pricing will work if the entering firm in uncertain regarding
the market demand or some determinant of post-entry pricing
such as incumbent’s marginal cost.
–
If entrant can predict post-entry price, its decision to enter or
not will be independent of the incumbent’s strategy.
–
In a model developed by Milgrom and Roberts, entrant is
assumed be uncertain regarding incumbent’s marginal cost.
–
Incumbent can be either a high cost producer or a low cost
producer.
–
If the incumbent is a low cost producer, it can pick a low price
to signal its low cost and deter entry.
–
The price picked by the low cost incumbent will be too low to
be rational had the incumbent been a high cost producer
Hence the low price becomes a credible signal of low marginal
cost.
–
If the incumbent is a high cost producer, it cannot deter entry.
A firm using the predatory pricing strategy sets the price below
short run marginal cost with the expectation of recouping the
losses when the rival exits.
Limit pricing is directed at potential entrants while predatory
pricing is directed at entrants who have already entered.
If all the entrants can perfectly foresee the future course of
incumbent’s pricing, predatory pricing will not deter entry.
In experimental settings with complete information, predation did
not occur.
Chain store paradox: Many firms commonly perceived to
engage in predatory pricing.
With uncertainty, predatory pricing can deter entry.
If the incumbent does not slash prices, other challengers may
consider him ‘easy’ rather than ‘tough’.
An incumbent can be ‘tough’ either due to low costs or due to an
irrational desire for market share.
To deter entry, incumbent has to establish a reputation for
toughness.
By holding excess capacity, the incumbent can credibly threaten
to lower the price if entry occurs.
Since an incumbent with excess capacity can expand output at a
low cost, entry deterrence will occur even when the entrant is
completely informed about the incumbent’s intentions.
Incumbent has a sustainable cost advantage.
Market demand growth is slow.
Incumbent cannot back-off from the investment in excess
capacity.
Entrant is not the type trying to establish a reputation for
toughness.
If the entrant can convince the incumbent that it does not pose a
long term threat, incumbent may be reluctant to adopt costly
entry deterring strategies (using the opponent’s strength to
one’s advantage).
Netscape’s open source strategy may be Judo move against
Microsoft whose strength is in standardized rather than
customized software.
Puppy dog ploy : Placate top dog, enjoy available scraps.
In a price war, larger players may have better staying power
(larger cash reserves, better access to credit).
Larger players also incur a greater cost (especially if they do not
have a cost advantage).
The more a firm believes it can outlast its rivals, the more willing
it will be to begin and continue with a price war.
A firm that faces exit barriers is well positioned to engage in a
price war.
A firm can also try to convince its rivals that it can outlast them
(For example, by claiming that they are making money even
during the price war).