Week 5 - Entry and Exit

Question 1

How do we define entrants?

Answer 1

As new firms that begin to produce and sell in existing markets

Question 2

How does entry threaten incumbents?

Answer 2

• Reduces market share
• Increasing competition
• Reducing profitability

Exit has opposite effect in an industry

Question 3

What elements are asymmetrical between incumbents (those within) and entrants?

Answer 3

• Sunk cost for incumbents is incremental cost for entrants
• Established relationships with customers and supplier not easy to replicate
• Learning curve effects
• Switching costs for customer

Question 4

What does a firm do before entry into a market?

Answer 4

-Cost Benefit Analysis (comparing sunk cost of entry with PV of the post-entry profit stream)

Question 5

What do sunk costs of entry range from?

Answer 5

• Investment in specialised assets to obtaining govt licences

Question 6

What do post-entry profits depend upon?

Answer 6

Depend on demand and cost conditions as well as post-entry competition

Question 7

What are some of the implication of entry and exit into/from a new market?

Answer 7

• Managers should account for unknown potential future competitors
• Managers of new entrant firms need to find capital to grow since survival and growth go hand in hand
• Managers should be aware of entry/exit conditions of industry and how they can change

Question 8

What are barriers to entry?

Answer 8

Factors that:
- allow the incumbents to earn economic profit while

-making it unprofitable for the new firms to enter the industry.

Question 9

How do we classify barriers to entry?

Answer 9

• structural barriers (natural advantages) and

- strategic barriers (incumbents’ actions to deter entry).

Question 10

When do structural barriers to entry exist?

Answer 10

When:

• Incumbents have cost advs
• Incumbents have marketing advantages
• Incumbents protected by favourable gov policy and regulation

Question 11

What are the 3 main types of ‘natural’ barriers to entry?

Answer 11

• Control of essential resources by the incumbent
• Econ of scale and scope
• Marketing adv of incumbency

Question 12

What’s meant by control of essential resources?

Answer 12

Resources that incumbents have that makes it harder for entrants to face

e. g.
- Patents
- Special know-how

Question 13

How can entrant be deterred by economies of scale?

Answer 13

If EofS significant potential entrants may face cost disadv
- Incumbent strategic reaction may be to further lower price and cut into entrants profits

(SEE GRAPH TO HELP WITH EXPLANATION)

Question 14

How can entrants be deterred by economies of scope?

Answer 14

Cost disadvantage here too

• Econ of scope exist when multiple product lines produced in same plant
• Econ of scope in marketing due to upfront costs of achieving brand awareness by entrants

Question 15

How can incumbents exploit their marketing advantage?

Answer 15

Exploit brand umbrella to introduce new products more easy than entrants
- Bran umbrella make it easy for incumbent to negotiate vertical channel (e.g easier to get shelf space with established brand)

Question 16

How can barriers to exit affect strategy

Answer 16

(SEE GRAPH)

essentially need to think twice about entering market

Question 17

What are some of the elements to Barriers to exit?

Answer 17

Sunk costs make MC of staying low

• Obligations and commitments to suppliers and employees are sunk costs
• Relationship specific assets may have low resell value
• Gov regulation also barrier to ext

Question 18

How can Incumbents create strategic barriers to entry?

Answer 18

• Expanding capacity
• Resorting to limit pricing
• Resorting to predatory pricing

Question 19

How can these entry barrier strategies work?

Answer 19

• Incumbent must earn higher profits as a monopolist than as a duopolist
• Strategy should change entrants expectations regarding post entry competition

Question 20

How much of available capacity do manufacturers use?

Answer 20

Avg capacity use of 80%

-Often have excess capacity in anticipation of future growth

Question 21

How does holding excess capacity pose a risk to entrants?

Answer 21

If incumbent holds excess capacity can threaten to lower price if entry occurs, since there’s sunk cost to facilitate low cost production that is committed before entry occurs.
-Incumbent with excess capacity can therefore expand output at relatively low cost that will/may prevent entry

Question 22

What are the conditions for excess capacity to work to deter entry?

Answer 22

When:

• Incumbent has sustainable cost adv
• Market demand growth slow, meaning that state of ‘excess capacity’ sustainable
• Incumbent cannot back off from investment in excess capacity (its sunk cost)

Question 23

What is limit pricing?

Answer 23

where products are sold by a supplier at a price low enough to make it unprofitable for other players to enter the market.

Question 24

EXAMPLE OF STRATEGIC LIMIT PRICING

Answer 24

SUPER IMPORTANT TO KNOW HOW TO DO SEE GOD DAMN NOTES

Question 25

EXAMPLE OF HOW TO MAKE STRATEGIC CHOICE (LIMIT PRICING)

Answer 25

SEE IN NOTES

Question 26

Is Limit Pricing Rational in the long term?

Answer 26

• if further multiple periods considered, incumbent has to set price low in each period to deter entry in following period
• Incumbent may be better off being Cournot Duopolist than limit pricing forever as a monopolist

Question 27

Is Limit Pricing rational?

Answer 27

Potential entrants can rationally anticipate that the post-entry price will not be less than the Cournot equilibrium price, if the profits of the incumbent would be higher compared to when they do limit pricing.

Question 28

When can limit pricing potentially be effective?

SEE GRAPH

Answer 28

• If economies of scale i.e Avg Cost decreases with output, limit pricing might still be feasible
• If monopolist can set prices so that residual demand results in negative profits for all potential quantities
• Limit Pricing may still not be sustainable as it is not necessarily the best response by the monopolist to the potential entrant’s actions

Question 29

How can we make limit pricing credible via pre-commitment?

Answer 29

If incumbent monopolist can pre-commit with strategy which is consistent with blocking entry, then limit pricing to block entry can be more credible

e.g. Comitting to sunk investment which reduces its flexibilty to make threat of blocking entry credible

SEE TREE DIAGRAM OF CHOICES IN NOTES

Question 30

What counts as the inflexible technology/Raising Sunk costs?

Answer 30

• R&D - Invest earlier to reduce costs/increase quality of product in later period, to maximise NPV of profits
• Advertising Expenses: Requires potential entrant to engage in substantial amount of advert expenditure before being able to enter market
• Govt regulation (‘Grandfathering’) - Firms with older technologies have adv if not subject to same environmental regulation
• Tie in with other products (Broadband,Phone Line,Calls)
• Raise switching cost

Question 31

What is Predatory Pricing?

Answer 31

Involves setting the price below SRMC with expectation of recouping the losses via monopoly profits once rival exits
- Predatory Pricing if price below SRMC or (to ease computation) average cost

Question 32

Who is Predatory Pricing directed towards?

Answer 32

Directed at entrants who’ve entered while limit pricing is directed at potential entrants

Question 33

Is Predatory Pricing rational?

PT 1

Answer 33

If all entrants can perfectly foresee the future course of incumbent’s pricing, predatory pricing will not work

Question 34

What is the Chain Store Paradox?

Answer 34

Many firms are commonly perceived to engage in predatory pricing even when irrational to expect predatory pricing to deter entry

Question 35

Is Predatory Pricing Rational? (PT 2)

Answer 35

Simple economic models indicate that predatory pricing is irrational

Either the firms’ pricing strategies are irrational or the models are incomplete.

Game theoretic models that include uncertainty and information asymmetry show that predation can be a rational strategy.

Question 36

In what situations where limit pricing and Predation are rational?

Answer 36

• Incumbent wants the entrant to lower its expectations for post entry price
• Entrant lacks information about the incumbent’s costs
• Incumbent’s pricing strategy can alter entrant’s expectation when there is asymmetric information

Question 37

What model looks at the entrant’s dual uncertainty?

Answer 37

Saloner’s model, entrant uncertain about both

• Incumbent’s cost
• Lvl of demand

If incumbent prices below monopoly price regardless of cost,

• The entrant may infer either demand low or incumbent cost low
• In either case entry deterred

Question 38

What are some of the entry deterring strategies?

Answer 38

• Aggressive price reductions to move down the learning curve
• Intensive advertising to create brand loyalty
• Acquiring patents
• Limit Pricing
• Holding excess capacity
• Limit Pricing and Predatory Pricing with uncertainty with regard to demand and incumbent cost conditions

Question 39

What is typology of entry conditions (Bain)?

Answer 39

Markets can be characterized by whether:

• The existing barriers to entry are structural or strategic and
• Entry deterring strategies are feasible

Leads to three types of markets with regards to entry conditions

Question 40

What are the three types of markets in Bain’s typology?

Answer 40

Blockaded entry:
Entry is Infeasible due to Structural Barriers, thereby making Strategic Barriers irrelevant

Accommodated entry:
Structural Barriers are Low, and Strategic barriers are ineffective or prohibitively costly, and as a result so incumbents should simply “accommodate” entry

Deterred entry:
Structural Barriers do not blockade entry and Entry deterring strategies are not only effective but also cost effective

Deterred entry is the only market type in which incumbents have appropriate incentives to employ strategic entry barriers.