Eko YuliantoErika Sugiarto

Entry Entry Beginning of production and sales by a new firm in Beginning of production and sales by a new firm in a marketa marketEntry has two effectsEntry has two effects – reduced market share – intensified market competition

Can take two formsCan take two forms – entry by a new firm (ex. Dreamworks SKG) – entry by an existing firm diversifying into a new market (ex. Microsoft entering gaming systems market)

Acquisition is not entry: merely change of identityAcquisition is not entry: merely change of identityExit Exit A firm ceases to produce in a market A firm ceases to produce in a marketExit is the reverse processExit is the reverse processExit could also take different formsExit could also take different forms – A firm may simply fold up (Example: PanAm) – A firm may discontinue a particular product or product group or leave a particular market (Peugeot leaves the U.S. market)

Dunne, Roberts and Samuelson (DRS): entry and exit inDunne, Roberts and Samuelson (DRS): entry and exit in different different industries in the U.S. (1963-1980) found that:industries in the U.S. (1963-1980) found that: – – Entry and exit is pervasiveEntry and exit is pervasive– – EEntrants are generally small if they are newntrants are generally small if they are new– – MMost entrants do not survive 10 yearsost entrants do not survive 10 years, but those that do grow , but those that do grow precipitously.precipitously.–– Entry and exit rates vary by industryEntry and exit rates vary by industry

As part of planning for the future,As part of planning for the future, managers should account for managers should account for thethe unknown future competitors. unknown future competitors.

Diversifying firms pose a greater threatDiversifying firms pose a greater threat to the incumbents since to the incumbents since they tend tothey tend to build bigger plants than other entrantsbuild bigger plants than other entrants..

Managers of new firms need to find capitalManagers of new firms need to find capital for growth sincefor growth since survival and growth go handsurvival and growth go hand in hand. in hand.

Managers should be aware of the entry andManagers should be aware of the entry and exit conditions of exit conditions of the industry and how thesethe industry and how these conditions change over time due toconditions change over time due to technological changes, regulation and othertechnological changes, regulation and other factors factors

Barriers to entry are factors that allow theBarriers to entry are factors that allow the incumbents to earn incumbents to earn economic profit while it iseconomic profit while it is unprofitable for the new firms to enter unprofitable for the new firms to enter thethe industry. industry.Barriers to entry can be classified intoBarriers to entry can be classified into : :– – Structural barriers to entry andStructural barriers to entry and– – Strategic barriers to entryStrategic barriers to entry

Three entry conditions according to Joe BainThree entry conditions according to Joe Bain are are

– – Blockaded entryBlockaded entry Entry is considered to be blockaded whenEntry is considered to be blockaded when the incumbent does not need to the incumbent does not need to take anytake any action to deter entry action to deter entry

– – Accommodated entry Accommodated entry Structural barriers may be low and strategicStructural barriers may be low and strategic barriers may be ineffective in deterring barriers may be ineffective in deterring entryentry or simply not cost effectiveor simply not cost effective

– – Deterred entryDeterred entry.. Entry is not blockadedEntry is not blockaded Entry deterring strategies are effective inEntry deterring strategies are effective in discouraging potential rivals and are costdiscouraging potential rivals and are cost effectiveeffective Deterred entry is the only condition underDeterred entry is the only condition under which the incumbents should engage inwhich the incumbents should engage in predatory acts.predatory acts.

• Asymmetry between incumbent firms and entrants is due to sunk costs that the incumbent has incurred but the entrants has not.

• Asymmetries also arise from relationships with customers and suppliers that can take years to build.

• Asymmetries can also arise when incumbents move down the learning curve or when it is costly for a consumer to switch from one seller to another.

If economies of scale are significant,If economies of scale are significant, incumbent may face a incumbent may face a high threshold ofhigh threshold of market share to be profitablemarket share to be profitable..

Incumbent’s strategic reaction to entry mayIncumbent’s strategic reaction to entry may further lower price further lower price and cut into entrant’sand cut into entrant’s profits. profits.

If entrant succeeds, intense price competitionIf entrant succeeds, intense price competition may ensue. may ensue.

Economies of scope in production may existsEconomies of scope in production may exists when multiple when multiple products that share inputs andproducts that share inputs and production technology areproduction technology are produced in theproduced in the same plant. same plant.

Economies of scope in marketing are due toEconomies of scope in marketing are due to the bulky up the bulky up front expenditure an entrant hasfront expenditure an entrant has to incur to achieve to incur to achieve comparable brandcomparable brand awareness as the incumbent’s brandawareness as the incumbent’s brand..

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Incumbent can exploit the brand umbrellaIncumbent can exploit the brand umbrella (different products (different products sold under the samesold under the same brand name) to introduce new products brand name) to introduce new products moremore easily than new entrants caneasily than new entrants can..

The brand umbrella can make it easy for theThe brand umbrella can make it easy for the incumbent to incumbent to negotiate the vertical channelnegotiate the vertical channel (Example: It is easier to get (Example: It is easier to get shelf space withshelf space with an established brand). an established brand).

Exploitation of the brand name andExploitation of the brand name and reputation is not risk-free. reputation is not risk-free.

If the new product is unsatisfactory, customerIf the new product is unsatisfactory, customer dissatisfaction dissatisfaction may harm the image of themay harm the image of therest of the brands.rest of the brands.

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Barriers to exit are factors that make the firmBarriers to exit are factors that make the firm continue producing continue producing under such conditionsunder such conditions which would not have encouraged the firm which would not have encouraged the firm toto enter. enter.

Examples of such barriers are specializedExamples of such barriers are specialized assets laborassets labor agreements, commitment toagreements, commitment to suppliers and governmental suppliers and governmental regulations.regulations.

Exit if cannot make an acceptable return onExit if cannot make an acceptable return on assets assets

Exit barriers existExit barriers exist– – when there are fixed costswhen there are fixed costs– – when there are relationshipspecific assetswhen there are relationshipspecific assets

Some examples of entry deterring strategiesSome examples of entry deterring strategies are limit pricing, are limit pricing, predatory pricing andpredatory pricing and capacity expansion capacity expansionFor these strategies to workFor these strategies to work – – Incumbent must earn higher profits as aIncumbent must earn higher profits as a monopolist than as a monopolist than as a duopolist andduopolist and –– The strategy should change the entrants’The strategy should change the entrants’ expectations expectations regarding post-entry competition regarding post-entry competition (incumbent’s strategies (incumbent’s strategies should be credible)should be credible)

Contestable Markets and Entry DeterrenceContestable Markets and Entry DeterrenceIn a perfectly contestable market, aIn a perfectly contestable market, a monopolist sets the price at monopolist sets the price at competitivecompetitive levels levelsIf there is a possibility of a If there is a possibility of a hit and run entryhit and run entry (zero sunk cost) the (zero sunk cost) the market is contestablemarket is contestableIf the market is contestable, it is not worth theIf the market is contestable, it is not worth the monopolist’s while monopolist’s while to adopt entry deterringto adopt entry deterring strategies strategies

An incumbent using the limit pricing strategyAn incumbent using the limit pricing strategy will set the price will set the price sufficiently low to discouragesufficiently low to discourage entrants entrantsThe entrant observes the low price andThe entrant observes the low price and concludes that the concludes that the post entry price will be lowpost entry price will be low as well and decides not to enteras well and decides not to enterCharge a low price Charge a low price before entrybefore entry – entrant is put off by the low – entrant is put off by the low priceprice

When multiple periods are considered, theWhen multiple periods are considered, the incumbent has to incumbent has to set the price low in eachset the price low in each period to deter entry in the next period to deter entry in the next periodperiod. . Thus, the incumbent never gets to raise theThus, the incumbent never gets to raise the price and does price and does not reap the benefits of entrynot reap the benefits of entry Deterrence. Deterrence.Even in a two period setting, limit pricingEven in a two period setting, limit pricing equilibrium is not equilibrium is not subgame perfectsubgame perfect..Potential entrants can rationally anticipatePotential entrants can rationally anticipate that the post-entry that the post-entry price will not be less thanprice will not be less than the Cournot equilibrium price. the Cournot equilibrium price.

Limit pricing will work if the incumbent has a cost advantage over the entrant.

With a cost advantage, the incumbent can set the price slightly below entrant’s minimum average cost, ensuring that entrant can not make profits

Limit pricing will work if the entering firm in uncertain regarding the market demand or some determinant of post-entry pricing such as incumbent’s marginal cost.

If entrant can predict post-entry price, its decision to enter or not will be independent of the incumbent’s strategy.

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In a model developed by Milgrom and Roberts, entrant is assumed be uncertain regarding incumbent’s marginal cost.

Incumbent can be either a high cost producer or a low cost producer.

If the incumbent is a low cost producer, it can pick a low price to signal its low cost and deter entry.

The price picked by the low cost incumbent will be too low to be rational had the incumbent been a high cost producer Hence the low price becomes a credible signal of low marginal cost.

If the incumbent is a high cost producer, it cannot deter entry.

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A firm using the predatory pricing strategy sets the price below short run marginal cost with the expectation of recouping the losses when the rival exits.

Limit pricing is directed at potential entrants while predatory pricing is directed at entrants who have already entered.

If all the entrants can perfectly foresee the future course of incumbent’s pricing, predatory pricing will not deter entry.In experimental settings with complete information, predation did not occur.Chain store paradox: Many firms commonly perceived to engage in predatory pricing.

With uncertainty, predatory pricing can deterWith uncertainty, predatory pricing can deter entry. entry.

If the incumbent does not slash prices, otherIf the incumbent does not slash prices, other challengers may challengers may consider him ‘easy’ ratherconsider him ‘easy’ rather than ‘tough’. than ‘tough’.

An incumbent can be ‘tough’ either due toAn incumbent can be ‘tough’ either due to low costs or due to an low costs or due to an irrational desire forirrational desire for market share. market share.

To deter entry, incumbent has to establish aTo deter entry, incumbent has to establish a reputation for reputation for toughness.toughness.

By holding excess capacity, the incumbentBy holding excess capacity, the incumbent can credibly threaten can credibly threaten to lower the price ifto lower the price if entry occurs. entry occurs.

Since an incumbent with excess capacity canSince an incumbent with excess capacity can expand output at a expand output at a low cost, entry deterrencelow cost, entry deterrence will occur even when the entrant iswill occur even when the entrant is completely informed about the incumbent’scompletely informed about the incumbent’s intentions. intentions.

Incumbent has a sustainable cost advantageIncumbent has a sustainable cost advantage..

Market demand growth is slowMarket demand growth is slow..

Incumbent cannot back-off from theIncumbent cannot back-off from the investment in excess investment in excess capacity.capacity.

Entrant is not the type trying to establish aEntrant is not the type trying to establish a reputation for reputation for toughness.toughness.

If the entrant can convince the incumbentIf the entrant can convince the incumbent that it does not pose a that it does not pose a long term threat,long term threat, incumbent may be reluctant to adopt costlyincumbent may be reluctant to adopt costly entry deterring strategies (using theentry deterring strategies (using the opponent’s strength to opponent’s strength to one’s advantage)one’s advantage)..

Netscape’s open source strategy may beNetscape’s open source strategy may be Judo move against Judo move against Microsoft whose strengthMicrosoft whose strength is in standardized rather than is in standardized rather than customizedcustomized software. software.

Puppy dog ploy : Placate top dog, enjoy available scraps.Puppy dog ploy : Placate top dog, enjoy available scraps.

In a price war, larger players may have betterIn a price war, larger players may have better staying power staying power (larger cash reserves, better(larger cash reserves, better access to credit). access to credit).Larger players also incur a greater costLarger players also incur a greater cost (especially if they do not (especially if they do not have a costhave a cost advantage). advantage).

The more a firm believes it can outlast itsThe more a firm believes it can outlast its rivals, the more willing rivals, the more willing it will be to begin andit will be to begin and continue with a price warcontinue with a price war..A firm that faces exit barriers is wellA firm that faces exit barriers is well positioned to engage in a positioned to engage in a price warprice war..A firm can also try to convince its rivals that itA firm can also try to convince its rivals that it can outlast them can outlast them (For example, by claiming(For example, by claiming that they are making money even that they are making money even during thduring the price war).e price war).