Eko Yulianto Erika Sugiarto

Entry  Beginning of production and sales by a new firm in a market Entry has two effects – reduced market share – intensified market competition Can take two forms – entry by a new firm (ex. Dreamworks SKG) – entry by an existing firm diversifying into a new market (ex. Microsoft entering gaming systems market) Acquisition is not entry: merely change of identity Exit  A firm ceases to produce in a market Exit is the reverse process Exit could also take different forms – A firm may simply fold up (Example: PanAm) – A firm may discontinue a particular product or product group or leave a particular market (Peugeot leaves the U.S. market)

Dunne, Roberts and Samuelson (DRS): entry and exit in different industries in the U.S. ( ) found that: – Entry and exit is pervasive – Entrants are generally small if they are new – Most entrants do not survive 10 years, but those that do grow precipitously. precipitously. – Entry and exit rates vary by industry

As part of planning for the future, managers should account for the unknown future competitors. Diversifying firms pose a greater threat to the incumbents since they tend to build bigger plants than other entrants. Managers of new firms need to find capital for growth since survival and growth go hand in hand. Managers should be aware of the entry and exit conditions of the industry and how these conditions change over time due to technological changes, regulation and other factors

Barriers to entry are factors that allow the incumbents to earn economic profit while it is unprofitable for the new firms to enter the industry. Barriers to entry can be classified into : – Structural barriers to entry and – Strategic barriers to entry

Three entry conditions according to Joe Bain are – Blockaded entry  Entry is considered to be blockaded when the incumbent does not need to  Entry is considered to be blockaded when the incumbent does not need to take any action to deter entry take any action to deter entry – Accommodated entry  Structural barriers may be low and strategic barriers may be ineffective in deterring  Structural barriers may be low and strategic barriers may be ineffective in deterring entry or simply not cost effective entry or simply not cost effective – Deterred entry.  Entry is not blockaded  Entry is not blockaded  Entry deterring strategies are effective in discouraging potential rivals and are cost  Entry deterring strategies are effective in discouraging potential rivals and are cost effective effective  Deterred entry is the only condition under which the incumbents should engage in  Deterred entry is the only condition under which the incumbents should engage in predatory acts. predatory acts.

Asymmetry between incumbent firms and entrants is due to sunk costs that the incumbent has incurred but the entrants has not. Asymmetries also arise from relationships with customers and suppliers that can take years to build. Asymmetries can also arise when incumbents move down the learning curve or when it is costly for a consumer to switch from one seller to another.

If economies of scale are significant, incumbent may face a high threshold of market share to be profitable. Incumbent’s strategic reaction to entry may further lower price and cut into entrant’s profits. If entrant succeeds, intense price competition may ensue. Economies of scope in production may exists when multiple products that share inputs and production technology are produced in the same plant. Economies of scope in marketing are due to the bulky up front expenditure an entrant has to incur to achieve comparable brand awareness as the incumbent’s brand. – – – – –

Incumbent can exploit the brand umbrella (different products sold under the same brand name) to introduce new products more easily than new entrants can. The brand umbrella can make it easy for the incumbent to negotiate the vertical channel (Example: It is easier to get shelf space with an established brand). Exploitation of the brand name and reputation is not risk-free. If the new product is unsatisfactory, customer dissatisfaction may harm the image of therest of the brands. – – – –

Barriers to exit are factors that make the firm continue producing under such conditions which would not have encouraged the firm to enter. Examples of such barriers are specialized assets labor agreements, commitment to suppliers and governmental regulations. Exit if cannot make an acceptable return on assets Exit barriers exist – when there are fixed costs – when there are relationshipspecific assets

Some examples of entry deterring strategies are limit pricing, predatory pricing and capacity expansion For these strategies to work – Incumbent must earn higher profits as a monopolist than as a – Incumbent must earn higher profits as a monopolist than as a duopolist and duopolist and – The strategy should change the entrants’ expectations – The strategy should change the entrants’ expectations regarding post-entry competition (incumbent’s strategies regarding post-entry competition (incumbent’s strategies should be credible) should be credible) Contestable Markets and Entry Deterrence In a perfectly contestable market, a monopolist sets the price at competitive levels If there is a possibility of a hit and run entry (zero sunk cost) the market is contestable If the market is contestable, it is not worth the monopolist’s while to adopt entry deterring strategies

An incumbent using the limit pricing strategy will set the price sufficiently low to discourage entrants The entrant observes the low price and concludes that the post entry price will be low as well and decides not to enter Charge a low price before entry – entrant is put off by the low price

When multiple periods are considered, the incumbent has to set the price low in each period to deter entry in the next period. Thus, the incumbent never gets to raise the price and does not reap the benefits of entry Deterrence. Even in a two period setting, limit pricing equilibrium is not subgame perfect. Potential entrants can rationally anticipate that the post-entry price will not be less than the Cournot equilibrium price.

Limit pricing will work if the incumbent has a cost advantage over the entrant. With a cost advantage, the incumbent can set the price slightly below entrant’s minimum average cost, ensuring that entrant can not make profits Limit pricing will work if the entering firm in uncertain regarding the market demand or some determinant of post-entry pricing such as incumbent’s marginal cost. If entrant can predict post-entry price, its decision to enter or not will be independent of the incumbent’s strategy. – – – –

In a model developed by Milgrom and Roberts, entrant is assumed be uncertain regarding incumbent’s marginal cost. Incumbent can be either a high cost producer or a low cost producer. If the incumbent is a low cost producer, it can pick a low price to signal its low cost and deter entry. The price picked by the low cost incumbent will be too low to be rational had the incumbent been a high cost producer Hence the low price becomes a credible signal of low marginal cost. If the incumbent is a high cost producer, it cannot deter entry. – – – – –

A firm using the predatory pricing strategy sets the price below short run marginal cost with the expectation of recouping the losses when the rival exits. Limit pricing is directed at potential entrants while predatory pricing is directed at entrants who have already entered. If all the entrants can perfectly foresee the future course of incumbent’s pricing, predatory pricing will not deter entry. In experimental settings with complete information, predation did not occur. Chain store paradox: Many firms commonly perceived to engage in predatory pricing.

With uncertainty, predatory pricing can deter entry. If the incumbent does not slash prices, other challengers may consider him ‘easy’ rather than ‘tough’. An incumbent can be ‘tough’ either due to low costs or due to an irrational desire for market share. To deter entry, incumbent has to establish a reputation for toughness.

By holding excess capacity, the incumbent can credibly threaten to lower the price if entry occurs. Since an incumbent with excess capacity can expand output at a low cost, entry deterrence will occur even when the entrant is completely informed about the incumbent’s intentions. Incumbent has a sustainable cost advantage. Market demand growth is slow. Incumbent cannot back-off from the investment in excess capacity. Entrant is not the type trying to establish a reputation for toughness.

If the entrant can convince the incumbent that it does not pose a long term threat, incumbent may be reluctant to adopt costly entry deterring strategies (using the opponent’s strength to one’s advantage). Netscape’s open source strategy may be Judo move against Microsoft whose strength is in standardized rather than customized software. Puppy dog ploy : Placate top dog, enjoy available scraps.

In a price war, larger players may have better staying power (larger cash reserves, better access to credit). Larger players also incur a greater cost (especially if they do not have a cost advantage). The more a firm believes it can outlast its rivals, the more willing it will be to begin and continue with a price war. A firm that faces exit barriers is well positioned to engage in a price war. A firm can also try to convince its rivals that it can outlast them (For example, by claiming that they are making money even during the price war).