Copyright 2006 – Biz/ed Pricing Strategies and Contestable Markets

Copyright 2006 – Biz/ed Pricing Strategies and Contestable Markets

Copyright 2006 – Biz/ed Pricing

Copyright 2006 – Biz/ed Pricing Pricing – How a business approaches its pricing strategies depends on the market structure it operates in Pricing can be a means of competing – not only to take customers of rivals but to prevent competition from rivals

Copyright 2006 – Biz/ed Price Takers Price takers – have little or no control over the price they charge Perfect Competition – P = MR = AR = MC = AC  Firms have to take the price set by the market  Large number of sellers – each has small market share and therefore no control over the market  Examples may include agricultural products, some types of financial product – stocks and shares Price Leadership – Dominant firm sets price, rest have to take this price

Copyright 2006 – Biz/ed Price Leadership Price leadership occurs where a dominant firm in an industry in which products are good substitutes is able to set price which others in the industry, on account of their smaller size, will follow Examples include: Some commodity markets where there is a dominant seller, the computer software industry (Microsoft), petroleum, some forms of pharmaceutical products May tend to exist in ‘micro-markets’ rather than the whole company market – e.g., no real price leadership in cereal market except for Weetabix?

Copyright 2006 – Biz/ed Price Fixing Price Fixing – where firm/s fix prices at levels above equilibrium on account of their market power or through selling/distribution arrangements generally termed collusion. e.g. sports replica kits, children’s toys and games, steel, motor vehicles Cartels – Organised price fixing – e.g. OPEC (Organisation of Petroleum Exporting Countries) Price fixing is illegal – type in ‘price fixing’ into a search engine to get details of companies and organisations around the world accused of, and convicted of, price fixing!

Copyright 2006 – Biz/ed Price Discrimination Charging different prices for the same product or service. Necessity of distinctive markets with different price elasticities Necessity of being able to prevent movement between the markets Examples: train travel – peak time and off peak, electricity charges – off peak metering, telephone calls

Copyright 2006 – Biz/ed RPI minus/plus formulas (Redistribution Pricing) Price regime imposed on privatised utilities to help protect the public from monopoly exploitation of essential services (Remember RPI now replaced by the CPI) RPI minus – price changes in line with the annual rate of inflation minus a set percentage, e.g. RPI – 4% - if RPI was 3% implies the firm would have to look at cutting prices to consumers by 1% RPI plus – imposes maximum price increases, e.g. RPI +2%, if RPI was 2% firm only able to increase prices to customers by max 4%

Copyright 2006 – Biz/ed Contestable Markets

Copyright 2006 – Biz/ed Contestable Markets Theory developed by William J. Baumol, John Panzar and Robert Willig (1982) Helped to fill important gaps in market structure theory Perfectly contestable market – the pure form – not common in reality but a benchmark to explain firms’ behaviours

Copyright 2006 – Biz/ed Contestable Markets Key characteristics: –Firms’ behaviour influenced by the threat of new entrants to the industry –No barriers to entry or exit –No sunk costs –Firms may deliberately limit profits made to discourage new entrants – entry limit pricing –Firms may attempt to erect artificial barriers to entry – e.g…

Copyright 2006 – Biz/ed Contestable Markets Over capacity – provides the opportunity to flood the market and drive down price in the event of a threat of entry Aggressive marketing and branding strategies to ‘tighten’ up the market Potential for predatory or destroyer pricing Find ways of reducing costs and increasing efficiency to gain competitive advantage

Copyright 2006 – Biz/ed Contestable Markets ‘Hit and Run’ tactics – enter the industry, take the profit and get out quickly (possible because of the freedom of entry and exit) Cream-skimming – identifying parts of the market that are high in value added and exploiting those markets

Copyright 2006 – Biz/ed Contestable Markets Examples of markets exhibiting contestability characteristics: –Financial services –Airlines – especially flights on domestic routes –Computer industry – ISPs, software, web development –Energy supplies –The postal service?