CAS 5: Entry and Entry deterrence

- how do you know there's an exit barrier? - why do they exist? How are decisions made? what in the longer term? - what effect on exit/entry price do they have? - How can decisions on type of production technology and scale of capacity have an influence on competition and exit?

- Exit barriers exist when a firm stays in the market, yet given the opportunity to enter, it would not. - Exit barriers are the result of sunk costs (e.g. contractual obligations they still have to perform). Because these costs are *sunk*, marginal production is low, so it's beneficial to stay in the market to recover some of those costs. So they only take into account marginal cost when deciding whether to stay in or exit. However, in the long term, fixed investments have to be re=made, and then the firm will take into account the full cost of production again. - Exit barriers drive a wedge between Pentry and Pexit (this is lower). - technology with high fixed costs increases the exit barriers. -

- why is predatory pricing difficult to prove? - How to define predatory pricing from a competition policy perspective - When are anti-dumping duties levied?

- Hard to distinguish from 'healthy' price competition, especially in markets with declining demand. - "Set prices below cost with the intention to drive competitors out of the market, in order to maintain market dominance and market power in the long term." - if 1) Home firms need to be hurt by imports 2) import price below average price of foreign firm OR below PRICES in home market (price discrimination)

*Entry into a new market*: Single firm, multiple firms, and 2 firms yet only 1 can survive - access to technology - if a single firm has access to technology, then .. - if any firm can access technology - if a limited number of firms can access technology - what does a firm need when competing for monopoly rents with several other firms? - what is rent seeking behavior

- If a single firm has access to the technology (so monopolist), then it should wait to enter the market until operating revenues exceed operating costs, rather than merely looking at post-entry profits and sunk entry costs. - if any firm can access the technology, the MES and market size will determine the number of firms in this *competitive market*. - If there's a small number of firms, but the market can't support them all, pre-emptive entry and rent seeking behavior will dissipate all monopoly rents. - if several firms are competing for monopoly rents, the winner must have unique assets or abilities (asymmetries) if it hopes to earn positive profits. - Engaging in costly activities to increase chances of benefiting from available profits.

- what's a contestable market? - what's a requirement? - what do we see in the airline industry?

- Mere threat of entry limits incumbents ability to raise prices. - They require hit and run entry, yet this is hard to find as it requires no entry costs at all. - Airline industry: routes where there were already firms operating at the ends of the flight, had lower prices than routes that were exclusively theirs: the the threat of entry reduces prices (*they have lower entry costs*)

- What strategic difference between incumbents and entrants are there (2)? * What sort of entrants have less of a disadvantage? What can they do?

- Sunk costs. For entrants, these are incremental costs. - Relationships with customers and suppliers * Those with already sunk costs in related machinery or with installed base. They can use incumbent removing strategies instead of entry deterring strategies.

- Exogenous / structural barriers - Endo/exogenous barriers - Endogenous barriers.

- To *increase sunk entry costs* - *MES relative to market size*: Entrants either enter low scale and have cost disadvantage, or large scale, flood the market and risk price wars, moreover, if *high sunk costs*, failing is expensive - if large scale entry) - *Experience curve*: incumbents have greater cumulative output and 'lower variable costs' - *Government protection and regulation*: licenses, planning laws (location), patents B) - *Network externalities*: the more people use it, the more others benefit from it. - Lack of access of key inputs: incumbents can tie up essential inputs or distribution channels. (most effective when few channels available and hard to replicate) C) *Brand loyalty and reputation* it takes years to build up a reputation with customers and suppliers. Very important for durable and experience goods. *Strategic entry barriers*: limit pricing, predatory pricing, strategic bundling, excess capacity.

- What's the *only* goal of strategic entry barriers? - Strategic entry barriers only profitable when (3)

- To reduce expected post-entry profits of entrants - 1. it works: they deter entry by changing post entry expectations. 2. profits without entry minus engagement costs need to be higher than with entry: i.e. they should've benefited you. 3. not illegal / illegality cannot be proven

1. What's the problem with *strategic limit pricing?* (2) 2. When has it potential to succeed? 3. When does strategic limit pricing change entrants expectations about post entry price?

1A. It has no commitment value: setting low price now doesn't guarantee it in the future. 1B. It is conditional on entry taking place and once this happened, best option is to accommodate for the incumbent, and the entrant may know this. 2. if entrants are uncertain on *payoffs, costs OR intentions* of the incumbent (asymmetric information) 3. 3A. if they think incumbent has low costs so the response to entry is setting low prices. 3B. if they think the incumbent has aggressive intentions, e.g. market share strategy, and thus may respond aggressively to entry.

A) How can the chain store paradox be solved? B) Chain store paradox shows us the role of X and Y. C) Reputation or incumbency that really matters?

A) - Chain store paradox relies on ability to perfectly predict incumbents costs or intentions, i.e. limit/predatory pricing. However, if the potential entrant is not sure about the incumbents costs levels, market condition or intentions, degree patience.. entrants may be deterred. E.g. maybe incumbents' costs are THAT low, so it can sustain such a low price.. - By slashing prices, incumbents can build a reputation for toughness, which can increase effectiveness of predatory pricing. B) Uncertainty and Asymmetry C) Reputation rather than incumbency

A) Entry and exit: in a typical industry, X of the firms are less/more than X years old. Moreover, X of the firms will exit within the next X years. B) Despite high entry barriers, Aspartame market did experience entry. Why? C) What consequences does early entry have in a dynamic game?

A) 1/3 less than 5 years old 1/3 will exit within next 5 years B) 1. highly profitable industry - profits always attract 2. Patents were about to expire C) Profits = zero. Firms can always enter early, until the expected profit is 0. Then a firm wouldn't enter earlier as it would earn negative profits.

A)*Contestable Limit pricing* works when (4) B)How does it differ from strategic limit pricing? C) why contestable?

A)1. cost advantage of incumbent firms 2. *entry is unprofitable* at this price level 3. price is kept at same level, always 4. Firm can meet all demand at limit price. B)It doesn't rely on reduced expectations after entry: signal must be that the price will always kept at this level. It doesn't require uncertainty C) such a price makes the market non-contestable

Which Entry condition, according to Bain, should lead to what kind of act?

Blockaded and Accomodated entry do nothing Deterred entry: engage in predatory act

For what sort of products are strategic games more important?

Homogenous products: there's few alternatives to protect the market share and profits.

- Marketing advantages of incumbency: Explain - Risk ?

Incumbents use umbrella branding, which reduces sunk costs of introducing a new product, or thus achieves scope economies. Moreover, it also helps to negotiate in the vertical chain. If previous products were sucessfull, warehouses will more likely allocate shelf space for those new products. - Risk: if it fails, it can tarnish whole brand

Why do firms often overinvest in patenting, brand building or product differentiation?

It increases entry barriers!

When is Advertising, patenting and R&D most effective?

When investments are industry specific: entry and replication requires sunk costs. without it, hit and run is possible

Why are advertising, R&D and patenting superior to other entry barriers

1. Direct impact on profits is positive 2. Legal 3. Effectiveness remains if market grows 4. Quick replication is difficult due to experience effects and it takes time (brand names, R&D capabilities).

Why is it hard to find evidence on entry deterring behavior?

1. Firms don't want to tell it. 2. Marginal costs need be known, which is hard to figure out. 3. Hard to determine what entry rate would've been without such practices.

1. What is predatory pricing? 2. What is its ultimate aim? 3. What is it useful for? 4. What is its flaw?What's it called? What's a requirement for this flaw to be correct? 5. How can market growth / demand influence predatory pricing? 6. When is it most effective? 7. what uncertainty?

1. Predatory pricing is the act of setting the price so low to drive competitors out of the market, so to deter future entry. 2. to raise prices again after competitors exit. 3. to create reputation for toughness that changes potential entrants expectations about incumbent behavior. 4. since its aim is to raise prices again once competitor exits, potential entrants know the price will rise again, so they could enter. It's called the *chain store paradox* It's (chain store paradox) based on situation *without uncertainty* 5. Predatory pricing doesn't work if incumbent can't meet all demand. 6. most effective when the firm has a reputation for toughness or competes in multiple markets. 7. IF there's uncertainty about incumbent's costs, intentions or patience, it can work

Two types of strategic entry barriers:

1. Price are *always low*: strategic bundling and contestable limit pricing 2. threaten low prices *after entry*: predatory pricing, strategic limit pricing, history of price wars in the industry, strategic excess capacity (flood the market)

1. What is strategic bundling? 2. How is it similar to contestable limit pricing? 3. When does it work best?(1) 4. Another goal of bundling?

1. Strategic bundling is when a firm uses its dominant position in one market, to block entry in another market, by selling bundles of goods at a lower price than when they would be bought separately. 2. also relies in constant low prices 3. it works best when it has low marginal costs in the related market. 4. increase market share

1. Strategic excess capacity is credible because. B) what does it say / how does it work 2. it works best when (5)

1. it has lower costs and is irreversible, thus making the threat for lowering prices credible. B_ it communicates that the firm has greater incentives to engage in price war as excess capacity makes price war less costly and immediately possible (it creates output *flexibility*) 2. A) *cost advantage* , B) *no strong growth* (excess capacity can be maintained) and C) *no uncertainty*: excess capacity is visible. D) entrant will not want to build reputation for toughness themselves E) investment for excess capacity must be sunk (cannot be redeployed elsewhere)

Judo economics. Say what?

Refers to situations where size of incumbents is used against them. - Revenue destruction effect. - Sunk costs that hold incumbents back to invest in technologies that cannibalize existing assets.