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Competitive Intelligence

Competitive Intelligence. Week 7 Competing Across Time. Outline. Competing Dynamics Strategic Commitment Defining Commitment Commitment and competition Flexibility and Options Dynamic Pricing Uncooperative pricing Cooperative pricing. Competition. Firm has no influence on competition

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Competitive Intelligence

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  1. Competitive Intelligence Week 7 Competing Across Time

  2. Outline • Competing Dynamics • Strategic Commitment • Defining Commitment • Commitment and competition • Flexibility and Options • Dynamic Pricing • Uncooperative pricing • Cooperative pricing

  3. Competition • Firm has no influence on competition • Reduce costs so that MC < P • Differentiation • Firm can influence competition • Oligopolistic structure

  4. Strategic Commitment (1) • Major strategic decisions • Major investments Vs loss of flexibility • Sending clear signals to competitors • Visible and Understandable • Credible (no bluff and irreversible) • Hard and costly to reverse • Ex. Investments, most favoured customer clause, public statement about competitive moves

  5. 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?"

  6. Strategic Commitment (2) • Affects competition • Induces competition to behave less aggressively • Induces competitors to become more aggressive • Other factors • Capacity utilisation rates, horizontal differentiation

  7. Strategic Commitment (3) • Tough Commitments (No Matter What) • Cournot: Capacity expansion • Bertrand: Price reduction • Soft Commitments (Else) • Cournot: Capacity adjustment • Bertrand: Price adjustment

  8. Cournot Revisited

  9. Cournot Equilibrium(Chap 5) • 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

  10. Sequential Decision:Stackelberg Model • 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

  11. Response to commitment • As in Stackleberg model, firm 2 adopts strategic substitutes adjustment (e.g. Cutback, reduce output as in Cournot) • If firm 2 responds aggressively, it adopts strategic complements (More action, reduce prices as in Bertrand) • Other adjustment/responses: • Prices, quantities, R&D, advertising, sales, channels

  12. Pricing Levels • Monopolistic pricing (MR = MC) • Competitive pricing (P = MC) • Cournot equilibrium (Q adjustments) • Bertrand equilibrium (P adjustments) • Horizontally differentiated • No differentiation (competitive pricing)

  13. Pricing Levels • Monopoly ∏: MR = MCQ = 45, P = $55, ∏ = $2,025 • Cournot ModelQ = 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 • Collaborative pricing (Collusion?): Q = 22.5, P = $55 = $1012.50

  14. Dynamic Pricing • 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?

  15. Decision Theory • Anticipating competitors’ moves

  16. Game Theory p. 253, Q.3Z is First Mover 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)

  17. Decision Tree • Z keeps : W keeps .5 x 200 = 100 W drops .5 x 150 = 75 175 • Z drops: W keeps .5 x 230 = 115 W drops .5 x 180 = 90 205

  18. Decision Tree • Z keeps : W keeps .8 x 200 = 160 W drops .2 x 150 = 30 190 • Z drops: W keeps .1 x 230 = 23 W drops .9 x 180 = 162 185

  19. Dynamic PricingExample: Shell / Exxon • Situation: P = 100 – Q, MC = 20 Price = 40, Q = 30, ∏ = 600 per firm • Maximum price (Monopoly): Price = 60, Q = 20, ∏ = 800 per firm • Cournot: Price = 47.67, Q = 26.67, ∏ = 317 per firm • Price competition: Price = 20, Q = 40 ∏ = 0 per firm

  20. Shell’s Decision (p. 236) • Currently ∏ = 600, P = 40 • Or 11.54 weekly • Collaborative ∏ = 800, P = 60 • Or 15.38 weekly • Non collaborative scenario • One week trial ∏ = 0, P = 60 • Revert back to current situation • P = 40, ∏ = 11.54 weekly • Or 11.54 x 51 weeks= 588.54

  21. Nash Equilibrium:Cooperative Pricing

  22. Shell’s Decision Tree 695

  23. Shell’s Commitment • Announces that prices will go up • Announces that competitors’ prices will be immediately matched (“We will not be undersold”) • Tit-for-tat strategy

  24. Exxon’s reaction(Discount rate = 10%) • 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 • Exxon (collaborative): 15.38 + 15.38 /(1.002) + 15.38 /(1.002)2 + 15.38 /(1.002)3 + ... + 15.38 /(1.002)n = 760 • Remember that: if FV = PV (1+r)n then PV = FV/(1+r)n

  25. Competitive Pricing Strategies • Collusion pricing (ex. OPEC, commodity marketing boards) • Monopoly price / n firms • Non Cooperative • Bertrand: P = MC where Profit = 0 • Cooperative • Through rationality (NPV) • Power and retaliation … • Coordination … • Market Structure… • Facilitating Practices …

  26. 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”

  27. Coordination • Misreading competitors and possible effects • Traditions, conventions, firms’ status and role • Market structure and facilitating practices …

  28. Market structure and Cooperative Pricing • Homogeneity of goods or offer (-) • Market concentration (+) • Reaction speed and information (-) • Order size and frequency (-) • Firms’ asymmetries (-) • Price sensitivity (-)

  29. Price Competition and Facilitating Practices • 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 (+)

  30. Non Cooperative Pricing • 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

  31. Wrap up • 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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