Chapter 9 Competitive Interactions

1. Chapter 9 Competitive Interactions Keith Head SauderSchool of Business

2. The “take-away” for this chapter • Chapter 7 says international location strategy depends on four factors • -factor advantages • -PlEoS • -trade costs • -market size • Chapter 9 says we need to take into consideration interactions of competitors’ FDI decisions, although it is NOT the critical factor.

3. Road Map 0. Introduction • Should competitors stay together or separately? (Space dimension) • Marketing-crowding effects • Agglomeration effects • Common ground of preferences Two normal-form games • Timing of entry decisions (Time dimension) • First-mover advantages • Second-mover advantages (fast-follower’s advantages) One extensive-form game • One game involving several effects • Summary

4. IntroductionSpace factors Time factors A general game Summary China Retail Market

5. IntroductionSpace factors Time factors A general game Summary ChinaRetail Market • Based on 2005 estimation, China is the 7th largest retail market in the world. • Now Wal-Mart (US world 1st), Carrefour (France world 2nd), and Metro (Germany world 3rd), have come and competedin China market. • Wal-Mart 1996 the 1st super-center in Shenzhen 2006 56 stores in China • Carrefour 1995 the 1st hyper-store in Beijing 2006 70 hypermarkets and 225 discounts • Metro 1996 the 1st store in Shanghai 2006 30 discount, cash-only stores

6. IntroductionSpace factors Time factors A general game Summary Metro Carrefour Wal-Mart Shenzhen

7. IntroductionSpace factors Time factors A general game Summary Great Success of KFC in China

8. IntroductionSpace factors Time factors A general game Summary KFC and McDonalds in China KFC 1987 the 1st store in Beijing 1992 10 stores in China 1995 up to 71 stores 1996 the 100th store was set up stead-development stage Now more than 1400 stores in China McDonalds 1990 the 1st store in Shenzhen 1992 the largest store of McDonalds of the world in Beijing Now 680 stores in China

9. IntroductionSpace factors Time factors A general game Summary KFC(1987) McDonald Shenzhen (1990)

10. IntroductionSpace factors Time factors A general game Summary Knickerbocker’s framework • Oligopolistic Reaction (OR) is defined as The decision of one firm to invest overseas raises competing firms’ incentives to invest in the same country. • Key points of oligopolistic reaction • Oligopoly • Uncertainty of the overseas production costs • risk aversion

11. IntroductionSpace factors Time factors A general game Summary Location Choices for McDonald and KFC A symmetric case • Indifferent between two locations • Firms want to avoid each other.

12. IntroductionSpace factors Time factors A general game Summary Market-crowding effects • “Market-crowding” effects When there is a nearby competitor, the company has to charge a lower price and surrender market share. -lower market share harder to cover fixed costs -lower profit margins on each sale. -input prices pushed up or scarce “spaces” taken.

13. IntroductionSpace factors Time factors A general game Summary Market-crowding effects • Trade costs insulate a firm from competition from a distant rival.

14. IntroductionSpace factors Time factors A general game Summary Location Choices for McDonald and KFC • The previous pay-off form shows that the two firms avoid choosing the same local marketspatially separate themselves • What kind of pay-off forms are possibly consistent with the “matching location” phenomena?

15. IntroductionSpace factors Time factors A general game Summary Location Choices for McDonald and KFC When locatingtogether beats locating separately There is no conflict between the interests of the two firms—This set of payoffs is a “coordination game”.

16. IntroductionSpace factors Time factors A general game Summary Agglomeration economies • How could they benefit from locating near each other? • Information sharing/spillover • Encourage input suppliers to set up in the same area • “Agglomeration economies”-efficiency gains by staying together E.g. Silicon Valley, Hollywood • Low market-crowding effect +strong agglomeration economies co-location

17. IntroductionSpace factors Time factors A general game Summary Does it make sense to “match a rival’s move”? • Market-crowding effectsLow together • In the goods market • In factor markets • Agglomeration effectsHigh together • More information sharing (industry-level externality) • Stimulate more suppliers to set up nearby • Common ground of preferencesHigh together -similar targeted consumers (market segments) -similar factor intensities

18. IntroductionSpace factors Time factors A general game Summary Location Choices for McDonald and KFC • When Shenzhen is a “better” place • Different locations are better than co-location in Shenzhen. • Whoever moves first will choose Shenzhen—and earn higher profits! This is an example of a “first-mover” advantage.

19. IntroductionSpace factors Time factors A general game Summary Extensive-form Representation McDonald Sub-game Perfect Nash Equilibrium Beijing Shenzhen KFC KFC This is one of the two extensive-form representations of the previous normal-form game. Shenzhen Shenzhen Beijing Beijing 7 8 10 McDonald 5 8 KFC 5 10 7

20. IntroductionSpace factors Time factors A general game Summary First-mover Advantages (FMAs) • Definition An advantage gained by the first significant company to move into a new market • Notice First-mover≠ long-run business success • Features No competitor—monopolist—high profit margin —high market shares

21. IntroductionSpace factors Time factors A general game Summary How could FMAs lead to long-run business success? Channels? • Loyalty to brand • Localized and non-shared learning curve • AC declines when cumulative output rises • Market not large enough to accommodate two firms • Exclusive dealing contracts • Leverage the current monopoly power to the next period • Network economies • e.g. Personal bank business

22. IntroductionSpace factors Time factors A general game Summary Second-mover Advantages (SMAs) • Sometimes being the first-mover has disadvantages. • What leads to second-mover advantages in production location decisions? • Free-ride on “investments” made by the first mover • First mover already taught local consumers about product • First mover already taught local workers about modern production • First mover already settled legal issues with local government • Copying first mover’s successful decisions helps second-mover lower risk of making bad choices in an unfamiliar environment

23. IntroductionSpace factors Time factors A general game Summary Second-mover Advantages (SMAs) New born chick imitates a turtle with it's shell.

24. IntroductionSpace factors Time factors A general game Summary How did first movers do in China? • Auto industry • Volkswagen (Germany) moved early and was very successful. • Peugeot (France) also entered early and lost money for 12 years before exiting. • Personal care products • Proctor and Gamble entered early and has been very successful. • Wella entered soon after and failed

25. IntroductionSpace factors Time factors A general game Summary Location Choices for McDonald and KFC Locating together beats separate location and each firm has a preferred location (The battle of the sexes) “First-mover” advantage +matching the location

26. IntroductionSpace factors Time factors A general game Summary The Battle of the Sexes

27. IntroductionSpace factors Time factors A general game Summary Summary 1 phenomenon—interaction of competitors’ FDI decisions Oligopolistic reaction 2 time dimension advantages • First-mover advantages • Second-mover advantages 3 spatial factors • Market-crowding effects • Agglomeration effects • Common ground of preferences 4 games 1-2-3-4

28. IntroductionSpace factors Time factors A general game Summary Harder to cover fixed cost Example FC=$1000 Profit/goods=$10 minimal #=100 units Total local demand=100 units Only one firm exist; if there are two firms, equally dividingthe market, could either of them recover the fixed cost