Course notes

Competitive Intelligence
Week 7
Competing Across Time
1
Outline
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Competing Dynamics
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Strategic Commitment
Defining Commitment
Commitment and competition
Flexibility and Options
Dynamic Pricing
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Uncooperative pricing
Cooperative pricing
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Competition
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Firm has no influence on competition
Reduce costs so that MC < P
 Differentiation
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Firm can influence competition
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Oligopolistic structure
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Strategic Commitment (1)
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Major strategic decisions
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Major investments Vs loss of flexibility
Sending clear signals to competitors
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Visible and Understandable
Credible (no bluff and irreversible)
• Hard and costly to reverse
• Ex. Investments, most favoured customer clause,
public statement about competitive moves
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Marchionne's grand plan is to create
a global car giant by combining the
best pieces of Fiat and Chrysler. The
strategy makes sense on paper ....
"Chrysler can make it," says Hall.
"The question is, how committed is
Fiat to saving Chrysler?"
5
Strategic Commitment (2)
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Affects competition
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Induces competition to behave less
aggressively
Induces competitors to become more
aggressive
Other factors
 Capacity utilisation rates, horizontal
differentiation
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Strategic Commitment (3)
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Tough Commitments (No Matter
What)
Cournot: Capacity expansion
 Bertrand: Price reduction
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Soft Commitments (Else)
Cournot: Capacity adjustment
 Bertrand: Price adjustment
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7
Cournot Revisited
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Cournot Equilibrium
(Chap 5)
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Firms adjust quantities (Soft Commitment)
Market  P = 100 – Q
and
MC = 10
Market:
P = 100 – Q1 –Q2
∏1 : (100 - Q1 - Q2g) x Q1 – 10Q1
∏1 : (100Q1 - Q12 - Q1 Q2g) – 10Q1
∏1 : 90Q1 – Q12 –Q1Q2g
d∏1/dQ1: 90 – 2Q1 - Q2g
=0
Q1 = 45 - .5Q2g
and Q2:= 45 - .5Q1g
Q1 = 45 - .5 (45 - .5Q1) = 30
P = 100 – 30 -30 = 40
∏ = $30 x 30 = 900
Sequential Decision:
Stackelberg Model
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One firm takes the lead (Tough Commitment)
P = 100 – Q1 –Q2  100 - Q1 – (45 - .5Q1)
Q1 = 55 - .5Q1
∏1 = 55Q1 - .5Q12 - 10Q1
d∏1/dq = 45 - Q1 = 0
Q1 = 45
Q2 = 45 - .5Q1 = 22.5
P = 100 -45 – 22.5 = 32.5
∏1 = (45 x 32.5) – 10 x 45 = 1,012.50
∏2 = (22.5 x 32.5) – 10 x 22.5= 506.25
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Response to commitment
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As in Stackleberg model, firm 2 adopts strategic
substitutes adjustment (e.g. Cutback, reduce
output as in Cournot)
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If firm 2 responds aggressively, it adopts
strategic complements (More action, reduce
prices as in Bertrand)
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Other adjustment/responses:
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Prices, quantities, R&D, advertising, sales, channels
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Pricing Levels
Monopolistic pricing (MR = MC)
 Competitive pricing (P = MC)
 Cournot equilibrium (Q adjustments)
 Bertrand equilibrium (P
adjustments)
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Horizontally differentiated
 No differentiation (competitive pricing)
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Pricing Levels
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Monopoly ∏: MR = MC
Q = 45, P = $55, ∏ = $2,025
Cournot Model
Q = 30, P = $40, ∏ = $900
Stackelberg Model
Q=45/22.5, P = 32.5, ∏ = 1,012.5/506.25
Bertrand Model
Q = 45/45, P = 10 ∏ = 0
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Collaborative pricing (Collusion?):
Q = 22.5, P = $55 = $1012.50
Dynamic Pricing
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Why do firms in some markets seem to be able
to coordinate their pricing behavior and avoid
costly price wars, while in other markets intense
competition is the norm?
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Decision Theory
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Anticipating competitors’ moves
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Game Theory p. 253, Q.3
Z is First Mover
Walmart
Zellers(?)
Keep Prices
Drop Prices
Keep Prices
200/250
150/280
Drop Prices
230/190
180/220
If Z keeps prices, then W drops prices: Z = 150
If Z drops prices, then W drops prices: Z = 180
Z should drop prices to minimize loss (-30)
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Decision Tree
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Z keeps :
W keeps .5 x 200 = 100
W drops .5 x 150 = 75
175
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Z drops:
W keeps .5 x 230 = 115
W drops .5 x 180 = 90
205
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Decision Tree
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Z keeps :
W keeps .8 x 200 = 160
W drops .2 x 150 = 30
190
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Z drops:
W keeps .1 x 230 = 23
W drops .9 x 180 = 162
185
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Dynamic Pricing
Example: Shell / Exxon
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Situation: P = 100 – Q, MC = 20
Price = 40, Q = 30, ∏ = 600 per firm
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Maximum price (Monopoly):
Price = 60, Q = 20, ∏ = 800 per firm
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Cournot:
Price = 47.67, Q = 26.67, ∏ = 317 per firm
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Price competition:
Price = 20, Q = 40 ∏ = 0 per firm
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Shell’s Decision (p. 236)
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Currently
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Or 11.54 weekly
Collaborative ∏ = 800, P = 60
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∏ = 600, P = 40
Or 15.38 weekly
Non collaborative scenario
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One week trial
∏ = 0, P = 60
Revert back to current situation
P = 40, ∏ = 11.54 weekly
Or 11.54 x 51 weeks= 588.54
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Nash Equilibrium:
Cooperative Pricing
Exxon
Yes
Shell
No
Yes
800 / 800
589 / 612
No
612 / 589
600 / 600
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Shell’s Decision Tree
Price Increase
.5
Exp(Profit)
Exxon Follows
400
.5
Exp(Profit)
Exxon doesn’t
295
695
No Increase
Exp(Profit)
600
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Shell’s Commitment
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Announces that prices will go up
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Announces that competitors’ prices
will be immediately matched (“We
will not be undersold”)
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Tit-for-tat strategy
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Exxon’s reaction
(Discount rate = 10%)
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Exxon (non-collaborative):
23.08 + 11.54/(1.002) + 11.54/(1.002)2 + 11.54/(1.002)3 + ...
+ 11.54/(1.002)n = 582
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Exxon (collaborative):
15.38 + 15.38 /(1.002) + 15.38 /(1.002)2 + 15.38 /(1.002)3 +
... + 15.38 /(1.002)n = 760
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Remember that:
if FV = PV (1+r)n
then PV = FV/(1+r)n
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Competitive Pricing
Strategies
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Collusion pricing (ex. OPEC, commodity
marketing boards)
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Non Cooperative
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Monopoly price / n firms
Bertrand: P = MC where Profit = 0
Cooperative
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Through rationality (NPV)
Power and retaliation …
Coordination …
Market Structure…
Facilitating Practices …
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Power and Retaliation
Tit-for-Tat (niceness, provocabiblity,
forgiveness); “we will not be
undersold”
 Grim Trigger “we will drop our prices
until you choke to death”
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Coordination
Misreading competitors and possible
effects
 Traditions, conventions, firms’ status
and role
 Market structure and facilitating
practices …
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Market structure and
Cooperative Pricing
Homogeneity of goods or offer (-)
 Market concentration (+)
 Reaction speed and information (-)
 Order size and frequency (-)
 Firms’ asymmetries (-)
 Price sensitivity (-)
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Price Competition and
Facilitating Practices
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Price leadership through economies of
scale or from other forms (+)
Advanced Announcements (+)
Strategic commitment (+)
Buying power of customers
- Most favored customer clause
- Uniform price delivery (+)
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Non Cooperative Pricing
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Managerial incentives (sales, volumes and
market share)
Industry cycle (growth, maturity, decline)
Short term or long term views (and
motivations)
Managerial egos
Managerial incompetency
Bad mannered managers
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Wrap up
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Market structure, Number of firms and Price competition
Commitment
Pricing equilibrium: Anywhere from monopoly to pure
competition
Pricing strategies: Anywhere from collusion to grim trigger
Pricing behaviors: Anywhere from civilized to wild
Importance of industry analysis
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