Structural characteristics(5) 4. Sunk expenditures by consumers and product differentiation If consumers are required to make sunk expenditures to use a product, then they will be reluctant to switch to the product of a new firm Switching brands will require them to make similar expenditures to utilize a different brand The existence of sunk expenditures for consumers will create brand loyalty Switching costs arise from a number of sources, including (1)costs of learning how to use a product; (2) investments in complementary roducts; 3)loss of network benefits; (4)learning about quality; or 5)aless acceptable match between preferences and attributes of the product. These requires that an entrant compensate consumers for their costs of switching by offering a higher quality, offering a lower price, or engaging in extensive promotion, or all three, any of which are likely to reduce the profitability of entry Product differentiation means that consumers do not view the offerings of different firms as perfect substitutes. Product differentiation can raise entry barriers when it reduces the size of the market and thereby enhances the effect of economies of scale
Structural characteristics (5) • 4. Sunk expenditures by consumers and product differentiation. • If consumers are required to make sunk expenditures to use a product, then they will be reluctant to switch to the product of a new firm. Switching brands will require them to make similar expenditures to utilize a different brand. • The existence of sunk expenditures for consumers will create brand loyalty. • Switching costs arise from a number of sources, including (1) costs of learning how to use a product; (2) investments in complementary products; (3) loss of network benefits; (4) learning about quality; or (5) a less acceptable match between preferences and attributes of the product. These requires that an entrant compensate consumers for their costs of switching by offering a higher quality, offering a lower price, or engaging in extensive promotion, or all three, any of which are likely to reduce the profitability of entry. • Product differentiation means that consumers do not view the offerings of different firms as perfect substitutes. Product differentiation can raise entry barriers when it reduces the size of the market and thereby enhances the effect of economies of scale
Structural characteristics(6) Incumbent products that have characteristics that appeal to most consumers or have greater cross-elasticities of demand with an entrants product will reduce the profitability of entry In the first case, there may only be small niche markets available that are insufficient, given economies of scale, to support entry. In the second case, a greater cross-price elasticity of demand means that the entrant can expect more aggressive price competition postentry
Structural characteristics (6) • Incumbent products that have characteristics that appeal to most consumers or have greater cross-elasticities of demand with an entrant’s product will reduce the profitability of entry. • In the first case, there may only be small niche markets available that are insufficient, given economies of scale, to support entry. In the second case, a greater cross-price elasticity of demand means that the entrant can expect more aggressive price competition postentry
Strategic behavior by incumbents(1) Because the profitability of entry depends on the nature of competition postentry and therefore the behavior of the incumbent, it is possible that the preentry behavior of the incumbent can contribute to the height of entry barriers or entry deterrence by reducing the profitability of entr The strategies available for incumbents to raise the height of barriers to entry generally fall into one of the following 3 categories 1. Aggressive postentry behavior Incumbent firms can act strategically to commit to aggressive behavior postentry This is typically done by reducing economic costs postentry by making sunk investments prior to entry Reducing the marginal cost of production will typically make threats by the incumbent to act aggressively postentry credible sunk capacity or deliberately choosing technology of production that substitutes sunk fixed costs for avoidable variable costs In some industries marginal cost depends on accumulated experience this is called learning by doing. An incumbent can lower its costs by overinvesting in learning by doing. How? By producing more than the monopoly output prior to entry
Strategic behavior by incumbents (1) • Because the profitability of entry depends on the nature of competition postentry and therefore the behavior of the incumbent, it is possible that the preentry behavior of the incumbent can contribute to the height of entry barriers or entry deterrence by reducing the profitability of entry. • The strategies available for incumbents to raise the height of barriers to entry generally fall into one of the following 3 categories: • 1. Aggressive postentry behavior. • Incumbent firms can act strategically to commit to aggressive behavior postentry. • This is typically done by reducing economic costs postentry by making sunk investments prior to entry. • Reducing the marginal cost of production will typically make threats by the incumbent to act aggressively postentry credible (sunk capacity or deliberately choosing technology of production that substitutes sunk fixed costs for avoidable variable costs). • In some industries marginal cost depends on accumulated experiencethis is called learning by doing. An incumbent can lower its costs by overinvesting in learning by doing. How? By producing more than the monopoly output prior to entry
Strategic behavior by incumbents(2) 2. Raising rival's costs Incumbent firms can act strategically to raise the costs of a potential entrant, thereby putting them at a competitive disadvantage and reducing the profitability of entry EXample: exclusive supply contracts and supermarket data 3. Reducing rivals revenues Incumbent firms can act strategically to reduce the revenue of a potential entrant, once again reducing the profitability of entry Strategies that reduce the revenue of rivals work by lowering the demand for an entrants product. This can be done by creating or increasing consumer switching costs
Strategic behavior by incumbents (2) • 2. Raising rival’s costs. • Incumbent firms can act strategically to raise the costs of a potential entrant, thereby putting them at a competitive disadvantage and reducing the profitability of entry. • Example: exclusive supply contracts and supermarket data. • 3. Reducing rival’s revenues. • Incumbent firms can act strategically to reduce the revenue of a potential entrant, once again reducing the profitability of entry. • Strategies that reduce the revenue of rivals work by lowering the demand for an entrant’s product. This can be done by creating or increasing consumer switching costs
A dominant firm with a competitive fringe(1) Much more common are near monopolies-firms that have a marker ctice Monopolies are easy to work with in theory, but harder to find in prad share of less than 100%, but are still large enough that they dominate the industry in terms of price setting In other words a dominant firm still possesses considerable market power 2 factors contribute to the rise of a dominant firm 1. The dominant firm is more efficient than its rivals and as a result enjoys a significant cost advantage because its size allows it to realize extensive economies of scale 2. the dominant firm has a superior product The small producers are usually assumed to have no market power-they act as price takers, supplying output competitively in response to Whatever market price the dominant firm chooses to set These small producers are collectively called competitive fringe and their total suppl at any given price will correspond to their horizontally summed marginal cost curve-to the amount that they would supply at any price in a perfectly competitive market The effect of the competitive fringe is to dampen, but not eliminate the dominant firms control over price. In essence the readiness of the fringe to supply makes the dominant firms perceived demand more elastic, and hence like a monopolist who faces a more elastic demand curve, her profit-maximizing price is lower
A dominant firm with a competitive fringe (1) • Monopolies are easy to work with in theory, but harder to find in practice. Much more common are near monopolies-firms that have a market share of less than 100%, but are still large enough that they dominate the industry in terms of price setting. In other words a dominant firm still possesses considerable market power. • 2 factors contribute to the rise of a dominant firm: • 1. The dominant firm is more efficient than its rivals and as a result enjoys a significant cost advantage because its size allows it to realize extensive economies of scale. • 2. The dominant firm has a superior product. • The small producers are usually assumed to have no market power-they act as price takers, supplying output competitively in response to whatever market price the dominant firm chooses to set. These small producers are collectively called competitive fringe and their total supply at any given price will correspond to their horizontally summed marginal cost curve-to the amount that they would supply at any price in a perfectly competitive market. • The effect of the competitive fringe is to dampen, but not eliminate, the dominant firm’s control over price. In essence, the readiness of the fringe to supply makes the dominant firm’s perceived demand more elastic, and hence like a monopolist who faces a more elastic demand curve, her profit-maximizing price is lower