entry deterrence spring 20031 entry deterrence. spring 20032 why entry is bad (a reminder) u more...

Entry Deterrence Spring 2003 1

Entry Deterrence


Why Entry is Bad (A Reminder)

More firms means a smaller share of the pie even if prices are unaffected.

More firms means it is harder to sustain tacit collusion. Hence prices could fall as well.


For Some Firms Entry not an Issue Legally protected monopoly

Patents, copyrights, other IP Exclusivity

Various telecom in “old” Europe Post office in America Spectrum, bandwidth limits

Economies of scale create “natural” monopoly Land-line telecom Cable TV Electricity transmission

Network externalities eBay Windows

Convergence and Swiss-army-knife

networks


The Problem

Entrant

Incumbent

enter

stay out

fight

acquiesce

-1,2

5,6

0,10


The Problem More Generally

Entrant

Incumbent

enter

stay out

fight

acquiesce

Ef,If

Ea,Ia

Es,Is

Ea > Es > Ef

Is > Ia > If


Remember: Game Theory as the Ghost of Christmas Future Need to take steps today that

make fighting credible; or make entry unattractive; i.e., Es > Ea; or

develop a reputation for being crazy; or develop a reputation for fighting; or signal toughness.


Make Fighting Credible

Install “doomsday devices” For example

advertise heavily that you will beat any competitors price.

build excess capacity to make Bertrand competition credible.


Excess Capacity as Doomsday Device

Consider a monopoly incumbent deciding how much capacity to build.

Naïve approach is to build capacity equal to demand at the monopoly price.

Why naïve? Because typically at monopoly output, there is

sufficient demand to attract entry. Moreover, because incumbent has limited capacity, it is

constrained to cooperate (avoid the Bertrand trap).


Excess Capacity as Doomsday Device Suppose prior to entry, however, incumbent

builds enough capacity to serve all demand at any price above marginal cost.

Now if entrant enters, the firms risk being in the Bertrand trap, because incumbent has capacity to serve the entire market at a price equal to marginal cost.

Entrant is deterred from entering (as long as it believes Bertrand competition will ensue).


A Caveat on Capacity as a Doomsday Device Just because incumbent alone has this capacity

doesn’t guarantee Bertrand trap if entry – need to have reason to think incumbent will “pull the trigger.” Incumbent enjoys sufficient cost advantage that excess

capacity makes credible predation against entrant. Sometimes the added capacity creates economies of

scale (DuPont in titanium dioxide) – especially valuable if demand is expected to grow.

Excess capacity makes credible that incumbent can seek to maintain/establish reputation for toughness (see slides later on).


Make Entry Unattractive

Ways to make entry unattractive lock up customers lock up suppliers


Locking up customers I

Frequent buyer (loyalty) programs Frequent-flier programs to block hub entry. But not all loyalty programs are for entry deterrence

purposes: Some are to raise consumer switching costs to lessen risk of

Bertrand competition With Hertz #1 Club Gold, there's no need to stop at any

counters at over 40 of the world's busiest airports. And at over 1,000 other locations around the world, simply go to the specially designated Gold counter, show your driver's license and pick up your keys. The annual membership The annual membership fee is only $50.fee is only $50. (From Hertz’s web cite; emphasis added.)

Some are forms of second-degree price discrimination (volume discounts).


Locking up customers II

Use contracts to lock-in customers Apollo & Sabre’s use of long-term contracts

with travel agents. IBM’s service contracts to limit entry into

punchcard market. Microsoft’s contract with OEMs concerning

operating systems. A danger with such contracts is that they

frequently run afoul of antitrust authorities.


Locking up customers III

Building brand loyalty Amazon.com Claritin

Loratadine (though – almost – won’t find this term on Schering-Plough’s web site for Claritin).

Went off patent last December, which means generic production possible.

In anticipation of entry, S-P sought and gained approval to make Claritin an OTC medication.

It also launched a huge ad campaign for Claritin.


Schering-Plough Why did S-P do what they did?

Much easier to enter when competition is for prescriptions Doctors less brand conscious Health plan formularies create incentives for doctors to prescribe

generics Much harder to compete against a brand imagine to end

consumers What else has S-P done?

Sued two would-be manufacturers of generic loratadine claiming patent infringement on metabolites of loratadine.

Introduced Clarinex (desloratadine).


Schering-Plough Why did S-P do what they did?

What else has S-P done?


Make Entry Unattractive

Locking up suppliers control key inputs sign suppliers to long-term contracts Alcoa


Develop a Reputation for Being Crazy

If entrant thinks you might carry out an incredible threat, then may think twice about entering against you.

Developing a reputation for being crazy requires doing apparently irrational things.


Game Theory in FilmFrom the Maltese Falcon: Spade

smiled at the Levantine and answered him evenly: “You want the bird. I’ve got it … If you kill me how are you going to get the bird? If I know that you can’t afford to kill me till you have it, how are you going to scare me into giving it to you?”

Game Theory in Film (continued)

“I see what you mean.” Gutman chuckled. “That is an attitude, sir, that calls for the most delicate judgement on both sides, because as you know, sir, men are likely to forget in the heat of the action where their best interest lies and let their emotions carry them away.”


WORD FOR WORD/MOB PSYCHOLOGY

Analyze This: Vincent Gigante, Not Crazy After All Those YearsBy ANDY NEWMAN(New York Times, April 13, 2003)

n enduring urban mystery was solved last week when Vincent (The Chin) Gigante, the Mafia leader who spent decades slobbering, muttering and wandering Manhattan in his bedclothes, admitted in a Brooklyn federal court that he had deceived the teams of psychiatrists who had evaluated his mental competency from 1990 to 1997 and found him to be suffering from various forms of dementia.


Develop a Reputation for Fighting

Entrant

Incumbent

enter

stay out

fight

acquiesce

-1,2

5,6

0,10

The one-shotgame


Develop a Reputation for Fighting

Suppose you fight all entrants. Suppose fought entrant exits. Present discounted value of fighting is

Present discounted value of acquiescing is

2 10 2 101

1

t

t

.

6 61

0

t

t

.


Develop a Reputation for Fighting So it is worth developing a reputation for fighting

if ½; that is, if the interest rate does not exceed 100%.

More generally, it is worth developing a reputation for fighting if

So more likely to develop reputation the closer Ia is to If or the greater the distance between Is and If.

II I I I

I Ifs a a f

s f

1 1

or .


A Digression on Reputation

Reputation sustained by future play very important in business: quality assurance personal integrity tacit collusion on price


Signaling Toughness

The beer & quiche modelThe beer & quiche model An incumbent monopolist can be either

tough or a wimp (not tough). An incumbent monopolist receives 4 if the

entrant stays out and 2 if the entrant enters. An entrant earns 2 if it enters against a

wimp incumbent, loses 1 if it enters against a tough incumbent, & gets 0 if it stays out.


Beer & Quiche Prior to the entrant’s decision to enter or stay out, the

incumbent gets to choose its “breakfast.” Specifically, the incumbent can have beer for breakfast or quiche for breakfast. Breakfasts are consumed in public.

A beer breakfast is less desirable than a quiche breakfast.

But costs differ according to type: a beer breakfast costs a tough incumbent 1, but a wimp incumbent 3.

Beer & Quiche

Nature

tough

wimp

[½]

[½]

Incumbent

Incumbent

Entrant Entrant

beer

beer

quiche

quiche

enter

enter

out

out

enter

enter

out

out

1,-1

3,0

-1,2

1,0

2,-1

4,0

2,2

4,0


Beer & Quiche

Equilibrium: Tough incumbent drinks beer; wimp incumbent eats quiche; entrant stays out against beer drinkers; and entrant enters against quiche eaters.

What are beer & quiche?


Beer & Quiche

Toughness Beer

Excess Capacity High Output

Low Costs Low Prices

Deep Pockets Beat up Rivals &Previous Entrants


Conclusions

Entry is undesirable Generally, can’t wait for the entrant to

arrive – must take action in advance (e.g., Schering-Plough). Remember the Ghost of Christmas Future.


Conclusions (continued …)

Strategies for deterring entry fall into five broad categories: Making fighting credible (sometimes necessary to carry

out other strategies). Make entry unattractive

Lock up consumers Lock up suppliers

Develop a reputation for being crazy Develop a reputation for fighting Signal toughness


Some of the Companies and Industries Mentioned Alcoa Amazon.com American Airlines (Sabre) DuPont eBay Hertz IBM Microsoft Schering-Plough UAL (Apollo)

Telecom Electricity

transmission Pharmaceuticals Titanium dioxide Airline

entry deterrence spring 20031 entry deterrence. spring 20032 why entry is bad (a reminder) u more...

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