industrial competitiveness analysis

8/12/2019 Industrial Competitiveness Analysis

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Economics of StrategySixth Edition

Copyright 2013 John Wiley& Sons, Inc.

Chapter 6

Entry and Exit

Besanko, Dranove, Shanley, and Schaefer


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Entry

Entrants are firms that produce and sell in

new markets Entry threaten incumbents in two ways.

The market share of the incumbents is reducedPrice competition is intensified


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Forms of Entry

Entry could take place in different forms

An entrant may be a brand new firmAn entrant may also be an established firm that is

diversifying into a new product/market

The form of entry is important for analyzingthe costs of entry and the strategic response

by incumbents


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Evidence on Entry and Eit

%unne& 'oberts and #amuelson !%'#" studied

entry and eit in $. #. industries. They find that( Entry and eit are pervasive in the $.#.

Entrants !eiters" are smaller than incumbents

!survivors." )ost entrants fail *uickly and the ones that don+t grow

precipitously

The rates of entry and eit vary from industry to industry.


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%'# Findings on Entry and Eit

,ver a five year horizon& a typical industry

eperienced - to percent turnoverAbout half the entrants were diversified firms and

the rest were greenfieldentrants !new firms".

About 0 of the eiters were diversified firmsthat continued to operate in other markets.

1onditions in an industry that encouraged entryalso fostered eit


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%'# Findings on Entry and Eit

$nlike new entrants& diversifying firms built plants

on the same scale as incumbents. The size of the eiters is about one third of the

average firms+.

2ithin 3 years of entry 40 of the entrants leavethe industry. The survivors double in size over thesame horizon.


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5mplication of %'# Findings for #trategy

As part of planning for the future& managers

should account for the unknown futurecompetitors

%iversifying firms pose a greater threat tothe incumbents since they tend to build

bigger plants than other entrants


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5mplication of %'# Findings for #trategy

)anagers of new firms need to find capital

for growth since survival and growth gohand in hand

)anagers should be aware of the entry andeit conditions of the industry and howthese conditions change over time.


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1ost 6enefit Analysis for Entry

A potential entrant compares the sunk cost of entry

with the present value of the post7entry profitstream

#unk costs of entry range from investment in

specialized assets to obtaining government licenses Post7entry profits will depend on demand and cost

conditions as well as post7entry competition


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6arriers to Entry

6arriers to entry are factors that

allow the incumbents to earn economic profit while making it unprofitable for the new firms to enter the

industry.

6arriers to entry can be classified into structural barriers !natural advantages" and

strategic barriers !incumbents+ actions to deter entry".


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#tructural 6arriers to Entry

#tructural barriers to entry eist when(

incumbents have cost advantages incumbent have marketing advantages

incumbents are protected by favorablegovernment policy and regulations


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#trategic 6arriers to Entry

5ncumbents can erect strategic barriers by(

epanding capacity resorting to limit pricing and

resorting to predatory pricing


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Typology of Entry 1onditions !6ain"

)arkets can be characterized by whether

the eisting barriers to entry are structural or strategicand

entry deterring strategies are feasible

Three possible entry conditions of a marketare 6lockaded entry

Accommodated entry

%eterred entry


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6lockaded Entry

Entry is considered blockaded when the incumbent

does not need to take any action to deter entry Eisting structural barriers are effective in

deterring entry


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Accommodated Entry

2ith accommodated entry& the incumbents

should not bother to deter entry This condition is typical of markets with growing

demand or rapid technological change

#tructural barriers may be low and strategicbarriers may be ineffective or not cost effective


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%eterred Entry

Entry is not blockaded

Entry deterring strategies are effective indiscouraging potential rivals and are costeffective

%eterred entry is the only condition underwhich the incumbents should engage in

predatory acts


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Asymmetry between 5ncumbents and Entrants

2hat is sunk cost for incumbents is

incremental cost for the entrants Established relationships with customers

and suppliers are not easy to replicate

8earning curve effects

#witching costs for the customers


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Types of #tructural 6arriers

The three main types of structural barriers to

entry are( control of essential resources by the incumbent

economies of scale and scope

marketing advantage of incumbency


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1ontrol of Essential 'esources

9ature may limit the sources of certain

inputs and the incumbents may be in controlof these limited sources

Patents can prevent rivals from imitating afirms products

#pecial know7how that is hard for the rivals

to replicate may be zealously guarded by theincumbents


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Economies of #cale and #cope

5f economies of scale are significant&

potential may face cost disadvantages. 5ncumbent+s strategic reaction to entry maybe to further lower price and cut intoentrant+s profits.

5f entrant succeeds& intense price

competition may ensue.


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Economies of #cale and #cope

Entrants can face cost disadvantages due to

economies of scope. Economies of scope in production eist when

multiple product lines are produced in the same

plant. Economies of scope in marketing are due to the

upfront cost of achieving brand awareness by

entrants.


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)arketing Advantage of 5ncumbency

5ncumbent can eploit the brand umbrella to

introduce new products more easily thannew entrants can.

The brand umbrella can make it easy for theincumbent to negotiate the vertical channel!Eample( 5t is easier to get shelf space with

an established brand"


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)arketing Advantage of 5ncumbency

Eploitation of the brand name and

reputation is not risk7free. 5f the new product is unsatisfactory&

customer dissatisfaction may harm theimage of the eisting products.


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6arriers to Eit

PEntry : the minimum price that will induce a

firm to enter an industry PEit : the minimum price that will induce an

incumbent firm to stay in an industry

PEntry ; PEit Eit barriers drive a wedge between PEntry

and PEit .


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6arriers to Eit

#unk costs make the marginal cost of staying

low. ,bligations and commitments to suppliers

and employees are sunk costs as well.

'elationship specific assets may have lowresale value.


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Prices that 5nduce Entry and Eit may %iffer


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Entry %eterring #trategies

#ome eamples of entry deterring strategies are

limit pricing& predatory pricing and capacityepansion.

For these strategies to work

5ncumbent must earn higher profits as a monopolist thanas a duopolist and

The strategy should change the entrants+ epectationsregarding post7entry competition


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1ontestable )arkets = Entry %eterrence

5f there is a possibility of a hit and run entry !zero

sunk cost" the market is contestable. 5n a perfectly contestable market& a monopolist

sets the price at competitive levels

5f the market is contestable& it is not worth themonopolist+s while to adopt entry deterringstrategies


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1ontestable 8imit Pricing

5ncumbent has ecess capacity and can set

prices below entrant+s marginal cost 5ncumbent can meet the market demand at

the low prices


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#trategic 8imit Pricing

Entrant has limited capacity or rising marginal costs

8imit pricing may mean sacrifice of profits orinability to meet market demand

8ow price can be an entry deterrent if entrant infers

that post entry price will be low.


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Price = Profits under %ifferent 1ompetitive 1onditions


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5s 8imit Pricing 'ational>

2hen multiple periods are considered& the

incumbent has to set the price low in each periodto deter entry in the following period.

The incumbent may be better off being a 1ournot

duopolist than limit pricing forever as amonopolist.


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5s 8imit Pricing 'ational>

Even in a two period setting& limit pricing

e*uilibrium is not subgame perfect. Potential entrants can rationally anticipate

that the post7entry price will not be less than

the 1ournot e*uilibrium price.


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Predatory Pricing

Predatory pricing involves setting the price

below short run marginal cost with theepectation of recouping the losses viamonopoly profits once the rival eits

Predatory pricing is directed at entrants whohave already entered while limit pricing is

directed at potential entrants.


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5s Predatory Pricing 'ational>

5f all the entrants can perfectly foresee the futurecourse of incumbent+s pricing& predatory pricingwill not work.

The chain store parado( )any firms are

commonly perceived to engage in predatorypricing even when it is irrational to epectpredatory pricing to deter entry.


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5s Predatory Pricing 'ational>

#imple economic models indicate that

predatory pricing is irrational Either the firms+ pricing strategies are

irrational or the models are incomplete.


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#ituations 2here 8imit Pricing = Predation are'ational

5ncumbent wants the entrant to lower its

epectations for post entry price Entrant lacks information about incumbents

costs.

5ncumbent+s pricing strategy can alterentrant+s epectation when there is

asymmetric information.


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8imit Pricing and %ual $ncertainty

5n


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Predatory Pricing and 'eputation

Predatory pricing can deter entry when the

incumbent seeks a reputation fortoughness.

5f the incumbent does not slash prices&other challengers may consider him @easy+rather than @tough+


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An incumbent can be @tough+

either due to low costsor due to an irrational desire for market share

or because there is other competition entrant is

unaware of.

6y slashing prices entrant is made to believethat the incumbent is tough.


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#ome well known firms enoy a reputation

for toughness after their rivals disappear. #ome aggressive strategies to seek market

share(

Announce market share goals

'eward for managers based on market sharerather than profits

f i i


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2ar of Attrition

Predatory pricing strategy can degenerate

into a war of attrition. 5f no one leaves in the early stages& a

prolonged price war can be bad for all the

firms in the industry.

Even the winner may be worse off compared

to not having had the price war at all.

2i i h 2 f A i i


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2inning the 2ar of Attrition

The more a firm believes it can outlast its

rivals& the more willing it to stay in the pricewar

A firm that faces eit barriers is well

positioned to engage in a price war.

A firm can also try to convince its rivals that

it can outlast them !For eample& byclaiming to be money even during the pricewar"

E 1 i


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Ecess 1apacity

For $. #. manufacturers average capacity

use is about B0.2hen capacity addition has to be lumpy&

firms may often have ecess capacity in

anticipation of future growth

A temporary down turn in demand may

leave the firms in an industry with ecesscapacity with no strategic overtones

i d


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Ecess 1apacity and Entry %eterrence

6y holding ecess capacity& the incumbent

can credibly threaten to lower the price ifentry occurs.

An incumbent with ecess capacity can

epand output at a low cost.

Entry deterrence will occur even when the

entrant as informed as the incumbent.

E 1 i d E %


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Ecess 1apacity and Entry %eterrence

Ecess capacity works to deter entry when

incumbent has a sustainable cost advantage&market demand growth is slow&

incumbent cannot back7off from the investment

in ecess capacity and entrant is not the type trying to establish a

reputation for toughness.

E t t+ #t t CD d E i


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Entrant+s #trategy( CDudo Economics

$se opponent+s strength to one+s advantage.

Entrant discourages the incumbent fromentry deterrence strategies by appearing to

be a non7threat in the long term

5ncurring large losses may not appearworthwhile to the incumbent.

E t % t i #t t i


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Entry %eterring #trategies

Aggressive price reductions to move down

the learning curve 5ntensive advertising to create brand loyalty

Ac*uiring patents

Enhancing reputation for predation

8imit pricing

olding ecess capacity

Entry before competitors to discourage


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Copyright 2013 John Wiley & Sons, Inc.

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industrial competitiveness analysis

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