1、Entry and Exit,Introduction,Incumbent firms formulate strategy taking into account the possibility of entry by new firms Entry has two effects reduced market share intensified market competition Can take two forms entry by a new firm entry by an existing firm diversifying into a new market Exit is t
2、he reverse process Acquisition is not entry: merely change of identity,Some Stylized Facts,Entry and exit is pervasive over a five year period in most industries 30-40% new firms enter 30-40% of existing firms exit entrants are generally small if they are new most entrants do not survive 10 years if
3、 they survive they grow rapidly: 60% fail, the remainder at least double in size patterns vary across industries,Strategic Implications,Firms should plan for entry by unknown firms realize that diversifying entrants can threaten incumbents expect most new ventures to fail quickly but survivors will
4、grow quickly in planning entry focus on how to manage rapid growth know the industry,Strategic implications (cont.),Entrants should consider costs of entry and exit: are there sunk costs? likely reaction of incumbents: aggressive or passive what has been the history of the market? barriers to entry
5、of various types,Barriers to Entry,Barriers can take two forms Structural incumbents have natural cost advantages cost location regulatory environment Strategic through deliberate actions of incumbents,A Taxonomy,Entry conditions can be classified into three types blockaded entry structural conditio
6、ns preclude entry without strategic actions accommodated entry structural barriers are low and there are no effective strategic barriers to entry deterred entry incumbents use specific strategies to deter entry,Structural Entry Barriers,control of strategic resources patents if not deliberately anti
7、-competitive economies of scale and scope cost advantage of incumbency ability to sustain a price war leave no “holes” in the market requires that some part of entry costs is sunk,Structural entry barriers (cont.),marketing advantages of incumbency exploit reputation and brand name risky if a new pr
8、oduct does not meet expectations access to distribution based on reputation,Barriers to Exit,Exit if cannot make an acceptable return on assets but consider only recoverable assets,$,Quantity,ATC,AVC,MC,PENTRY,An illustration of the entry/exit decisions,Do not enter unless expected price is at least
9、 PENTRY,Do not exit if price is greater than PEXIT,PEXIT,Exit barriers exist when there are fixed costs when there are relationship-specific assets,Strategic Entry Deterrence,An incumbent will adopt entry deterring strategies if monopoly is preferred to accommodated entry if the strategies affect ex
10、pectations of potential entrants about post-entry competition First condition is obvious unless the market is perfectly contestable Second condition requires that strategies are credible,Entry deterrence,There are several potential strategies that have been suggested limit pricing predatory pricing
11、capacity expansion,Limit pricing,Charge a low price before entry entrant is put off by the low price An illustration,suppose demand is P = 100 - Q,marginal cost is $10 per unit,fixed costs are $800 per annum,incumbent has monopoly in year one; faces potential entry in year 2,market closes at the end
12、 of year 2,The Example,$,Quantity,Demand,100,100,10,MC,An incumbent monopolist produces Q = 45 units;,MR,45,price = $55,55,Profit p.a. = (55 - 10)x45 - 800,= $1,225,Monopoly profit per period ignoring fixed costs,Suppose an entrant in period 2 with the same costs,Assume that the incumbent and entran
13、t are Cournot (quantity) competitors,The Example,$,Quantity,Demand,100,100,10,MC,Each firm produces 30 units in period 2;,MR,price = $40,Profit to each firm = (40 - 10)x30 - 800,= $100,Given this expectation entry will occur,60,40,The incumbents profit in period 2 is sharply down,The example (cont.)
14、,Can the incumbent deter entry? use the reasoning price low in period 1 the entrant will then expect an even lower price in period 2 entry will not happen I can then charge the monopoly price in period 2 suppose the incumbent charges $30 in period 1 the incumbent then expects a price no higher than
15、$30 in period 2 suppose that the price is actually $30,The example (cont.),aggregate demand is 70 units suppose that this is split equally the entrant expects profits of (30 - 10)x35 - 800 = -$100 with a lower price losses are even greater so the potential entrant should not enter the incumbent then
16、 has profits,(30 - 10)x70 - 800,Profit in the first period,+ $1,225,Monopoly profit in the second period,= $1,825,Limit pricing would appear to be successful in increasing profits,The Example (cont.),But this outcome is wrong: the logic is flawed why only two years? if more periods then the limit pr
17、ice might have to be sustained over a very long time for this to be acceptable the incumbent needs a strong cost advantage over potential entrants the supposed equilibrium is not credible technically, it is not subgame perfect the entrants supposed expectations regarding the incumbents post-entry ac
18、tions are unreasonable consider the full game in extensive form,The Entry Game,Incumbent,PL,Incumbent sets the limit price,PM,Incumbent sets the monopoly price,Out,Entrant,In,pI = $1,825; pE = 0,Entrant,Out,pI = $2,450; pE = 0,Incumbent,PL,pI = $500; pE = -$100,PC,pI = $700; pE = $100,In,Incumbent,P
19、L,pI = $1,125; pE = -$100,PC,pI = $1,325; pE = $100,Entrant decides whether to enter,Incumbent chooses its pricing strategy,The Entry Game,Incumbent,PL,PM,Out,Entrant,In,pI = $1,825; pE = 0,Entrant,Out,pI = $2,450; pE = 0,Incumbent,PL,pI = $500; pE = -$100,PC,pI = $700; pE = $100,In,Incumbent,PL,pI
20、= $1,125; pE = -$100,PC,pI = $1,325; pE = $100,If the Entrant enters the Incumbent will choose Cournot,PC,pI = $700; pE = $100,If the Incumbent sets the limit price the Entrant will enter,In,If the Entrant enters the Incumbent will choose Cournot,PC,pI = $1,325; pE = $100,If the Incumbent sets the m
21、onopoly price the Entrant will enter,In,The Incumbent will set the monopoly price,PM,Limit pricing is not a credible strategy,Limit Pricing Rescued,Can limit pricing be rational? what if the entrant is uncertain of the incumbents costs high-cost incumbent - enter low-cost incumbent - stay out then t
22、he low-cost incumbent can signal a price that induces the entrant to stay out but a high-cost incumbent might send the same signal for this to work the price signal by a low-cost incumbent must be impossible for a high-cost incumbent or there is additional uncertainty e.g. about demand,Predatory Pri
23、cing,Pricing intended to eliminate rivals more aggressive than limit pricing charge low price to drive out rivals then subsequently raise price Has similar credibility problems chain store paradox incumbent will not fight in a “last” market so will not fight in all previous markets,Predatory pricing
24、 (cont.),Paradox can be resolved if there is uncertainty about the incumbents “type” if “easy” then entry is profitable if “tough” then entry is unprofitable incumbent wants to develop a tough reputation Wal-Mart American Airlines develop routines that make managers tough reward on market share not
25、profits,Excess Capacity,Firms carry excess capacity capacity use generally around 80% economic reasons to cope with unexpected fluctuations in demand as a result of competition from new firms strategic reasons to deter entry convince potential entrants of toughness of incumbents potential entrants k
26、now that incumbents can expand output at low cost,Entry at limited scale,Potential entrants may be able to enter at low scale deterrence is costly incumbent may be inclined to ignore a small entrant so entrant needs credible mechanism to convince incumbents of small-scale entry “puppy-dog ploy” mode
27、rn manufacturing techniques may help micro-breweries,War of attrition,Firms have been accused of charging low prices to eliminate competition Standard Oil Toyota Wal-Mart but price wars are costly and uncertain firm with “deep pockets” will win but at the expense of considerable profits create exit barriers to influence rivals,
