Ch 11

Front 1

defintion of entry?

Back 1

The beginning of production and sales by a new firm in a market.

Front 2

how can you enter?

Back 2

By a brand new firm.
Fe: Dell Computers
By an established firm that is diversifying into a new market.
A market for a new product.
Fe: Apple i-Phone
A new geographical market.
Fe: Havaianas (flip-flops) introduction in Europe after the World Cup 1998.

Front 3

Effect of entry on the market?

Back 3

The market shares of incumbent firms (firms already in the market) reduces.
Competition intensifies.

Front 4

definition of exit?

Back 4

When a firm ceases to produce and sell in a market.

Front 5

how can you exit?

Back 5

A firm may simply fold up.
Fe: DSB Bank in the Netherlands.
A firm may discontinue a particular product or product group.
Fe: Sega exits the computer hardware market.
A firm may leave a particular geographic market segment.
Fe: Google China.

Front 6

Effect of exit on the market?

Back 6

The market shares of incumbent firms increases.
Competition becomes less.

Front 7

When will a firm enter?

Back 7

When the sunk cost of entry are lower than the net present value of the post-entry profit stream.

Front 8

Sunk costs?

Back 8

Fe: Range from investment in specialised assets to obtaining government licenses.

Front 9

Post-entry profit?

Back 9

Depend on demand and cost conditions as well as post-entry competition.

Front 10

definitions by bain and stigler?

Back 10

Definition (Bain, 1956):
Anything that allows incumbent firms to earn above-normal profits without the threat of entry.

Definition (Stigler, 1968):
A cost that must be borne by firms that seeks to enter an industry, but is not borne by firms already in the industry.

Message: Entry barriers reduce the likelihood of entry and affect the returns of both the incumbent and the entrant.

Front 11

Structural barriers to entry (natural advantages of incumbent firms), think of:

Back 11

Control of essential resources.
Protection by government policy and regulations.
Cost advantages (economies of scale and scope).
Marketing advantages.

Front 12

Strategic barriers to entry (incumbents’ actions to deter entry), think of:

Back 12

Expanding capacity.
Limit pricing.
Predatory pricing.

Front 13

In Bain’s typology markets are characterised by:

Back 13

Structural and strategic barriers to entry.
Entry deterring strategies.

Front 14

Three possible entry conditions of a market are:

Back 14

Blockaded entry.
Accommodated entry.
Deterred entry.

Front 15

Market Conditions
Blockaded entry:

Back 15

Incumbents do not take any action to deter entry  existing structural barriers are sufficiently effective.
Fe: Water company.

Front 16

Market Conditions
Accommodated entry:

Back 16

Incumbents should not bother to deter entry  structural barriers to entry may be low and strategic barriers may be ineffective or not cost effective.
Fe: Markets with rapid technological change.

Front 17

Market Conditions
Deterred entry:

Back 17

Incumbents deter entry  strategy to deter entry is (cost-) effective.
Fe: Site preemption in retail banking.

Front 18

entrants vs incumbents
Differences predominantly in terms of costs:

Back 18

Sunk cost for incumbents are incremental costs for entrant.
Fe: Shell, BP, Texaco  already made enormous investments in the past (sunk), while entrants have to make these costs steps by step (incrementally).
Established relationships with customers and suppliers are not easy to replicate.
Learning curve effects.
Fe: Gaining experience is time consuming  international expansion of banks.
Switching cost for customers from incumbent to entrant are often high.
Fe: Switching computer programs  WP versus Word.

Front 19

Structural Barriers to Entry (1)
Control of essential resources:

Back 19

Natural resources controlled by incumbents.
Role government?
Fe: Mining  diamonds.
Patents can prevent rivals from imitating a firms products.
Role government?
Fe: Medicine.
Special know-how that is hard to replicate for rivals.
Fe: Car manufacturers  Ferrari.

Front 20

Structural Barriers to Entry (2)
econmies of scale and scope

Back 20

If economies of scale are significant entrant may face cost disadvantages.
Fe: Capital intensive industries  oil-industry.
If economies of scope exist entrant may face cost disadvantages.
Multiple product lines are produced in the same plant.
Upfront costs of brand awareness are high for entrants.
Fe: Cereals Kellogg’s Cornflakes/Frosties/Smacks.

Front 21

Structural Barriers to Entry (3)
marketing advantages

Back 21

Incumbent can exploit the brand umbrella to introduce new product more easily.
Fe: Sony “make.believe” Playstation, tv’s etc.
Easier to negotiate the vertical chain.
Fe: Easier to get shelf space with an established brand.

Front 22

Barriers to Exit

Back 22

Different barriers to exit possible:
Sunk costs: Make the marginal costs of staying low.
Obligations and commitments to suppliers and employees are sunk costs as well.
Relationship specific assets may have low resale value.
Government regulations.
Fe: Railway firms.

Front 23

Strategic Barriers to Entry (1)

Back 23

Recap: When incumbent firms take explicit actions aimed at deterring entry.
Limit pricing.
Predatory pricing.
Capacity expansion.

For these strategies to work:
Incumbent firms must earn higher profits as a monopolist than as a duopolist and,
the strategy should change the entrants’ expectations regarding post-entry performance.

Front 24

Strategic Barriers to Entry (2)

Back 24

Limit pricing:
The incumbent sets the price sufficiently low to discourage entrants.
 If entrant infers that post-entry price will be low, entry may not be likely.

However:
Limit pricing may lead to sacrifice of profits or inability to meet market demand.

So? Smart?
Depends, when multiple periods are considered the incumbent may be better of being a duopolist then limit pricing forever as monopolist.

Front 25

Strategic Barriers to Entry (3)

Back 25

Predatory pricing:
Setting the price below short-run marginal cost expecting to recoup the losses via monopoly profits once the rival exits.

However:
If all entrants can perfectly foresee the future course of incumbent’s pricing, predatory pricing will not work.

So? Smart?
Depends on the information of the entrant.
And of, for example, the risk for a ‘war of attrition’.

Front 26

Strategic Barriers to Entry (4)

Back 26

Can limit pricing and predatory pricing be effective? Yes:
When the incumbent want the entrant to lower its expectations for post-entry price.
When the entrant lacks information about the incumbents costs.
When there is asymmetric information.
Fe: When the entrant does not know that the incumbent has valuable information on the entrant.

(For building a reputation of toughness!)

Front 27

Strategic Barriers to Entry (5)

Back 27

Expanding capacity:
By holding excess capacity the incumbent can credibly threaten to lower the price if entry occurs.

However: No however, look at the next slide!

So? Smart? Works to deter entry:
Incumbent has a sustainable cost advantage.
Market demand growth is slow.
Incumbent cannot back-off from the investment in excess capacity.

(Whenever the entrant is not trying to establish a reputation for toughness!)