MKT558:PRICING STRATEGIESProfessorBaojunJiang

CompetitiveStrategyandPricing Positivesumvs.negativesumgames Strategicforesightandbackwardinduction Costeffectiveresponsestocompetitorspricecut Direct(nonstrategic)effectvs.strategiceffect

POSITIVESUM VS.NEGATIVESUM GAMES

Positivesum,zerosum,ornegativesumgames

Pricewarisoftenanegativesumgamereducingindustryprofitsinlongruno Undercuttingpriceresultsinnogainifimmediatelyretaliatedby

competitorso Cuttingpricesrarelydrivescompetitorsoutofbusinesso Consumerreferencepricesbecomelowero Consumersbecomemorepricesensitiveandlessqualitysensitive

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3STRATEGIC FORESIGHT AND BACKWARD INDUCTION

Shrinkingpiebargaininggame Thisbargainingtaskinvolvessplitting$100betweenplayers. Johncanproposeanysplitof$100betweenMaryandhimself. Marycanacceptorrejecttheoffer.Ifsherejectsit,thepie(thetotalamountofmoneyavailable)shrinksby50%,butshecanproposeanysplitof$50betweenJohnandher.

IfJohnrejectsMarysoffer,thepieshrinksbyanother50%(i.e.,only$25remains).Johnthenhasthelastchancetoproposeanysplitof$25. IfMaryrejectsJohnsofferagain,bothofthemwillwalkawayemptyhanded.

IfyouwereJohn,whatwouldyouproposewhenyousplitthe$100?

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AWINNERTAKEALL CONTEST Everyplayersimultaneouslychoosesanumberfrom0to100(i.e.,withoutseeingothersnumbers)

Computetheaverageofallparticipants Definetargetnumber:0.7xtheaverage Thewinneristheplayerwhosenumberistheclosesttothetargetnumber

Thewinnersprizeis$10.

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GAME RESULTS FROM STUDENTS

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Caltech UCLA Wharton Germany SingaporeMean 21.9 42.3 37.9 36.7 46.1Target 15.3 29.6 26.5 25.7 32.2Standard Deviation 10.4 18.0 18.8 20.2 28.0Sample Size 27 28 35 67 98

Lesson: Know yourself and your opponents Your optimal choice depends on others actions Actions of your competitors vary across cultures, backgrounds,

education levels, their self-assessments, etc., but may be predicted

ONETIME MARKET ENTRY Anincumbentmonopolist(e.g.,SFO LAXismonopolizedbyUnited)

SouthwestAirline(SWA)istheonlypotentialentrant SWAmustdecidewhetherornottoenterthemarket

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SWA Enter United

DontEnter

Fight

Share

(0, 2)

(1,1)

(-1,-1)

SWAs Payoff UnitedsPayoff

REPEATED MARKET ENTRY

Anincumbentmonopolist(United) Manypotentialentrants,eachwishestoentersequentiallyeitherinthiscityorothercitiesUnitedserves

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Entrant Enter United

DontEnter

Fight

Share

(0, 2)

(1,1)

(-1,-1)

Entrants Payoff UnitedsPayoff

LESSON FROM MARKET ENTRY GAME

Differentiatebetweenonetimeandrepeatedstrategicinteractions Inonetimemarketentrygame,Unitedshouldshare Inrepeatedsetting,Unitedshouldfight,whichhelpsUnitedtoestablishareputationofbeingtoughsoastoscareofffuturepotentialentrants

Unitedshouldsacrificeimmediatelossforfuturegain(totheextentpotentialentrantsaredeterredinthisorothermarkets)

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COSTEFFECTIVE RESPONSES TO COMPETITORS PRICE CUT1. Proctor&Gamblesrevenuedrops18%becauseofcheaperstore

brandcleaningproductspromotedbysupermarkets.Whatcan/shouldProctor&Gambledo?

2. AsmallindependentTVnetworkcutsitsadrates.Whatcan/shouldbignetworksdo?

3. Youareamarketshareleader inUS.Aninternationalcompanyentersyourmarketwithapricecut.Whatshouldyoudo?

4. Yourcompetitor(inB2Bmarkets)isofferingdiscountstonewcustomerstoattractcustomersawayfromyou.Whatshouldyoudo?

5. NewsmallairlineofferscheaperfaresinaUnitedAirlinesmainroute.WhatshouldUAdo?

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DIRECT EFFECT VERSUS STRATEGIC EFFECT

Willreducedcostintheindustrybenefitallfirms?o Direct(nonstrategic)effectversusstrategiceffect

Willafirmmakehigherprofitsbyadvertisingthehiddenbenefitsofitsproductstothecompetitorscustomers?o Direct(nonstrategic)effectversusstrategiceffect

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TAKEAWAY FROM THIS LECTURE

Pricewarislikelyanegativesumgamehurtingindustryprofitabilityinthelongrun.

Usestrategicforesightwhenreactingtocompetitiono Knowyourcompetitorsandyourselfo Weighthecostsandbenefitsofyouractiono Differentiatebetweenonetimeandrepeatedinteractions

Costeffectiveresponsestoprice/competitivethreato Focusyourreactivepricecutononlythecustomersattractedbythe

competitorsoffero Focusyourreactivepricecutononlyincrementalvolumeatrisko Focusyourreactivepricecutonaparticulargeographicareaorproduce

linewherethecompetitorhasthemosttolose,relativetoyou,fromcuttingtheprice.

o Raisethecompetitorscostforitsdiscountingo Leverageanycompetitiveadvantagestoincreasethevalueofyourofferas

analternativetomatchingtheprice.

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