Transcript RIVALRY AFTER ENTRY

Hjemmeside til Konkurransestrategi (2003), Fagbokforlaget
How should the incumbent
behave?
SOL 310 – Competitive strategy
Lars Sørgard
Co-opetition, ch. 6-7 (see http://mayet.som.yale.edu/coopetition/index2.html)
Judo strategy, ch. 8 (see http://www.judostrategy.com/)
© Sørgard
Konkurransestrategi
1
Today’s topic
• Incumbent’s strategic decisions
– Deter an entrant?
– If accommodation, how to behave?
• Strategic commitment
– Direct effect
– Strategic effect
• How to signal an aggressive response?
© Sørgard
Konkurransestrategi
2
SUMO strategies
• If you are a dominant firm, how to respond
to entry?
– What to do before entry?
– What to do after entry?
• But what is the incumbent’s goal?
– High market share?
– In conflict with max profits, or not?
– Short run versus long run?
© Sørgard
Konkurransestrategi
3
SUMO strategy: A warning
• Fight to deter entry or force rival to exit
(predation) is often very costly
• The risk associated with predation:
– Large financial costs during the war
– Discounting: loss today, gain in the future
– Entry can take place after the war
• The argument in favour of predation is reputation
– Fight today in one niche, to signal that you are a tough
type that might fight in other niches
© Sørgard
Konkurransestrategi
4
Act before potential entry
• The incumbent has a first mover advantage
– Can make a decision that commits the firm in
the future
– Strategic commitment (or inflexibility)
Irreversible decision
Competition
© Sørgard
Stage 1: Strategic commitment
Stage 2: Meet in the market place
Konkurransestrategi
5
Why an irreversible decision?
• Costs associated with reversing the decision
– Takes time to reverse the decision
– Will not get back the total amount
• Then an element of sunk costs
• Broad definition of decisions
–
–
–
–
–
–
© Sørgard
Production plants
Advertising
Vertical integration
Mergers
Long term contracts
…..
Konkurransestrategi
6
But is it credible?
•
Two requirements
(1) It is not in your own interest to reverse the decision after
you have seen your rival’s action
- Must be a credible commitment
(2) Acts before the rival, so that it can react
- Must be an observervable action
•
•
Is a price war announcement before entry credible?
The incumbent has two options
(1) Deterrence
- Unprofitable with entry
(2) Accommodation
- Entrant acts soft (not aggressively) after entry
© Sørgard
Konkurransestrategi
7
Strategic commitment:
Two kinds of effects
• Direct effect
Irreversible
decision
Change rival’s
future
behaviour
• Strategic effect
Irreversible
decision
© Sørgard
Change own
future
behaviour
Konkurransestrategi
Change rival’s
future
behaviour
8
Strategic commitment:
Direct effect
Irreversible
decision
•
•
Change rival’s
future
behaviour
Incumbent’s decision has a direct effect on
the potential entrant’s profit
Two kinds of direct effects
(1) Raising rivals’ costs
(2) Reducing demand for rivals’ products
© Sørgard
Konkurransestrategi
9
Direct effect I:
Raising rivals’ costs
(1) Acquire input suppliers (upstream integration)
– ALCOA bought waterfalls
– Norcem bought areas with limestone
• Rivals are either foreclosed from purchasing
inputs, or have to buy at a higher price
– Fewer independent input suppliers
– The price the rivals have to pay increases, even if the
remaining suppliers do not have cost disadvantages
• BUT: a costly race to acquire input suppliers?
© Sørgard
Konkurransestrategi
10
Raising rivals’ costs cont.
(2) Trigger other cost increases in the industry
–
–
•
Propose standards etc that are costly
Not room for many firms in the industry
Make sure that the you have a competitive
advantage
(i) Accept higher wages?
-
Can hurt a rival more than you, if he is more labour intensive
(ii) Asymmetric standards?
© Sørgard
Norsk Hydro in Norway: fertilizers
Standard that is tailormade to Norsk Hydro, and not
tailormade to BASF
Konkurransestrategi
11
Direct effect II:
Reducing demand for rivals’ products
(3) Investment in advertising
– Increase the number of loyal consumers
– Rivals’ demand is smaller
• BUT: How does the incumbent then behave,
if entry actually takes place?
– Loyal consumers means that the incumbent has
less reason to cut prices
– The entrant can then expect a friendly welcome
in the market, and entry can be profitable
© Sørgard
Konkurransestrategi
12
Reducing demand cont.
(4) Integration downstream
– Write contracts with buyers
– Acquire retailers
• Potential entrants do not find enough buyers to
succeed with profitable entry
• But is that profitable for the incumbent?
• Or could it be that the price it has to pay for the
aquisitions is too high?
– An aquisition battle between incumbent and entrant
© Sørgard
Konkurransestrategi
13
Red. demand cont.: Acquisition
• Who wins the aquisition battle?
Incumbent
Entrant
?
Retailer 1
?
Retailer 2
CONSUMERS
• Incumbent owns Retailer 1
• Will incumbent acquire Retailer 2?
© Sørgard
Konkurransestrategi
14
Acquisition – the game
• If incumbent wins, it gains a monopoly
position towards consumers
– Monopoly profits: M
• If entrant wins, competition between them
– Duopoly profits (for each firm): D
• Incumbent’s max payment: M.- D  I
• Entrant’s max payment: D  E
© Sørgard
Konkurransestrategi
15
Acquisition – who wins?
• Who has the highest willingness to pay for Retailer 2?
• Incumbent the highest willingness to pay if:
M - D > D (which says that I > E)
 M > 2D
• This condition is always met
– Monopoly profit is higher than total duopoly profits
• The incumbent wins the acquisition
– Higher willingness to pay, since acquisition means no
competition
– The entrant only reaps a duopoly profit
© Sørgard
Konkurransestrategi
16
Red. demand cont.: Examples
• Integrating forward (Judo, p. 184)
– Coke and Pepsi bought their bottling networks in the
80s
– End of 90s, controlled 80% of their direct distribution
• Contract directly with customers
– Nutrasweet made deals with Coke and Pepsi before
HSC enter the US market
• Apply contracts mentioned earlier
– MCC to have the final move against a potential rival?
– Can wait, instead of cutting prices too early?
© Sørgard
Konkurransestrategi
17
Red. demand cont.: Microsoft
• Did numerous things to reduce the demand
the rival Netscape would face
– Required Internet explorer to be installed on all
new machines with Windows
– Numerous distribution channels required to
exclude sales of Netscape
– Imposed Internet Service Providers to boycott
Netscape
© Sørgard
Konkurransestrategi
18
Red. demand cont.: Microsoft
•
Paid AOL to drop Netscape (see Judo, pp.
185-194)
–
–
–
Bill Gates to AOL in 1996: ’How much do we
need to pay you to screw Netscape?’
Paid AOL $ 0.25 for every customer that shifter
to Internet Explorer
If AOL converted ’a substantial portion of its
installed base’ by a certain date, then
(1) $ 600.000 in bonus
(2) AOL icon on the Windows desktop
© Sørgard
Konkurransestrategi
19
Strategic commitment:
Strategic effect
Irreversible
decision
Change own
future
behaviour
Change rival’s
future
behaviour
• Commitment to change your own behaviour in the
future
• When it is observed, the rival’s best choice is to
change its own behaviour
• Would like to soften the rival’s behaviour
– Deter him from entering, or
– Encourage him to act less aggressively after entry
© Sørgard
Konkurransestrategi
20
Strategic effect: Capacity
• Installing a large capacity – Top Dog strategy
– The best response for a potential entrant is to install a
smaller capacity, or not to enter
• DuPont – titanium dioxide in the 70s (Judo, p.
180)
– Expected an increase in demand next decade (more than
500.000 tons increase)
– Expanded its own capacity by 500.000, to preempt
potential rivals
– Did not succeed in deterring all its rivals
– But became the dominant producer, and still it is
© Sørgard
Konkurransestrategi
21
Take-or-pay contract with supplier
• For any product you take, you agree to pay a
certain price, say $50 per ton
• You have to pay even for product you don’t take,
say $40 per ton (up to a quantity ceiling)
• Example of such a contract:
– Ceiling of 1000, and buys 900
– Then you pay $50 for 900, and $40 for 100
• Take-or-pay good for the supplier; it protects him
• As a buyer you in return ask for a discount
© Sørgard
Konkurransestrategi
22
Take-or-pay – act aggressively?
• It is a commitment for you as a buyer to act
aggressively
– You have a de facto low marginal cost
– Would therefore typical retaliate against a rival
• In turn, it dampens your rival’s incentive to act
aggressively
– A device to dampening competition
• Risky: What if your rival actually triggers
competition?
– Then firms end up competing very aggressively
© Sørgard
Konkurransestrategi
23
Strategic effect:
Brand proliferation
• A dominant firm can introduce many different
brands or versions of its product
– One brand for each niche
• Whatever niche the entrant decides to enter, it will
face a brand by the incumbent
– Tougher competition after entry, then what else would
have been the case
• Numerous examples of such a strategy
– Kelloggs in the US for cereals
– Orkla in Norway for detergents
© Sørgard
Konkurransestrategi
24
Brand Proliferation: AOL
• AOL attacked by Freeserve in UK in 1999
– Freeserve offered no subscription fee, and users paid
only per minute (for telephone line)
• JUDO: AOL could lose $ 150 mill if it matched
• Finally, it did cut the subscription fee with 45%
• Later it fighted back by introducing new brands
– Netscape Online – no subscription fee
– A third product: flat rate
• Then Freeserve had a JUDO problem
– Fight back with a flat rate, and lose existing revenues?
– AOL superior on ads and e-commerce
– Freeserve matched, and faced losses
© Sørgard
Konkurransestrategi
25
Fighting against entrant:
Market segmentation
• A dominant firm’s problem is its size
– Would lose a large revenue by cutting prices on all sales
• Then a more targeted response can make an
aggressive response more credible
– Brand proliferation
– Sign contract customer by customer
• Can corporate discount schemes be a problem for
entrants in the airline market?
© Sørgard
Konkurransestrategi
26
Fridstrøm on airlines:
• Incumbent airline can meet any challenger by
offering selective discounts to large, attractive
clients, making predation a more credible threat
• Selective discounts may lead to intense price
rivalry and to exits from the market
• Similarly, potential entrants might be deterred
• Thus, corporate discount schemes may be anticompetitive in a setting with a dominant, incumbent
carrier and smaller potential entrants
© Sørgard
Konkurransestrategi
27
Incumbent: Fight or not?
• If deterrence or predation is the choice, then
different ways to make it credible with fight
– Irreversible investments
– Market segmentation
• If entry takes place and no predation, then
the incumbent would like peace
– Take-or-pay contract
– Transparency (repeated game mechanism)
© Sørgard
Konkurransestrategi
28
Repeated interaction
• In a one shot game, a prisoner’s dilemma outcome
concerning price setting
– Firms have a dominant strategy to set a low price
• But firms meet at the market place day after day,
week after week, …
• Then a collusive outcome can be sustained,
without any legal contract
– Can be in a firm’s interest to set high rather than low
price
© Sørgard
Konkurransestrategi
29
To deviate, or not to deviate?
• If all firms set a high price, then each firm has a
trade off when considering to deviate
(1) Price cutting would lead to a larger market
share in the short run
(2) Price cutting would trigger a price war after deviation
• If (1) dominates, the firm would deviate and we
are back to the prisoner’s dilemma
– When I deviate, all other firm deviate
– The outcome would be static Nash equilibrium
© Sørgard
Konkurransestrategi
30
The trade off
Deviation
Profits
GAIN
Collusion
LOSS
Competition
Time
• When is the gain from deviating small?
• Is there anything the firms can do to make the gain
small and thereby promote collusion?
© Sørgard
Konkurransestrategi
31
A strategy of rapid response
• If the rivals responds quickly to deviation,
then less incentives to deviate
– The period where you undercut your rival is
short
– A price war (retaliation) starts early
• If you can signal a rapid response, then this
can prevent firms from deviating
• But how to assure a rapid response?
© Sørgard
Konkurransestrategi
32
How to assure a rapid response?
(1) Make the market transparent, so that you
observe any deviation
•
Everybody is quickly informed about prices and sales
of its rivals
So ’innocent’ exchange of information in an industry
can foster collusion?
Is Internet making industries more transparent?
•
•
•
Can make retaliation possible, but are you
willing and able to retaliate?
© Sørgard
Konkurransestrategi
33
Danish concrete
• Local sales of concrete, and firms gave secret
discounts to customers
• Competition authorities argued that more
information is generally good for consumers
– Each consumer can find the low price firm
– Other firms must match the low price firm
• In line with this argument, they starting
announcing secret rebates regularly
– Everybody was informed about net prices
– They then expected prices to be lower
© Sørgard
Konkurransestrategi
34
Danish concrete – what happened?
© Sørgard
Konkurransestrategi
35
How to signal a rapid response?
(2)
To act in a way so that any deviation will be
punished
• Meet-the-competition clause can be such a signal
– The punishment is guaranteed
– Accepting your rival’s coupons is such a signal
• Can also do that by word and action
– We will match any discount immediately
– Actually do so when your rival offers a discount
© Sørgard
Konkurransestrategi
36
How to achieve high prices?
(1) Direct communication
•
•
•
Direct communication is illegal in most countries
But one way communication, then?
Where is the limit?
–
–
Free Record Shop established in Oslo in January
1995
Interviewed in Aftenposten, december 94:
•
•
© Sørgard
’There is no reason to start a price war. .. We will talk with
the other chains. We hope that Akers Mic will raise its prices
when we do’,
Konkurransetilsynet questioned them in a meeting, but no
fines
Konkurransestrategi
37
Cont.: How to achieve high
prices?
(2) Structural and institutional aspects
•
–
–
High transportation costs and high tariffs
leads to sale in local markets
Sphere of influence established
Example: cement in Europe? …
•
•
© Sørgard
… or did they actually cooperate?
They were given large fines for secret market
sharing
Konkurransestrategi
38
Cont.: How to achieve high
prices?
(3) Signalling of strategy
• Signalling how they will act if the rival changes
his price
• Petrol in Norway
–
–
•
Price competition triggered by JET in 1996
Sent signal through the press to end the price war
Newspapers in New York (co-opetition, p. 202)
–
© Sørgard
Signalling price strategies in one market segment
(Staten Island)
Konkurransestrategi
39
Lifting the fog – News in NY
• New York Post ( ) and Daily News ( ) on
Staten Island, New York in 1994:
Prices
50
40
25
Time
© Sørgard
Konkurransestrategi
40
Petrol in Norway
• 19.12.96 in Dagens Næringsliv (Shell):
– ’Everybody is making a loss. .. Not sustainable in the
long run’
• 1.2.97 in Aftenposten (ESSO):
– ’ESSO will not in plain words encourage others to raise
their price’
• 8.2.97 in Dagens Næringsliv (Hydro/Texaco):
– ’Irrespective of the action by others, Hydro/Texaco will
set a price floor of 7.50’
© Sørgard
Konkurransestrategi
41
Petrol in Norway – cont.
• The other followed immediately:
– Statoil: ’In those areas where the price is increasing,
we will also raise our price’
– ’Jet is prepared to raise our prices, if the other firms do
so’
– ESSO: ’We are adjusting our prices’
• JET – transparency as a deliberate system:
– Our people check prices on other petrol stations two or
three times every day. If our rivals raise prices, we
follow. But we always have prices 30-40 øre below our
rivals.’
© Sørgard
Konkurransestrategi
42