T7StrategicManagementII (2017)Apunte Inglés
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Strategic Management II
1. Entry and exit - Chapter 6
Asymmetries among incumbents and potential entrants favor the development of strategic
barriers by one, and entry strategies by the other. We consider entry as the beginning of
production and sales by a new firm in a market. We consider exit as the withdrawal of a firm
from the market.
The processes of entry and exit are determinants of the structure of an industry. Modes of entry include newly created firms and diversifying firms that extend active product lines or geographic coverage. Modes of exit range from complete shutdown to redeployment of assets to other industries (lateral exit).
Entry Strategies An entry strategy is a choice to enter or not, and when and how to execute entry. The entrant analyzes the NPV resulting from entry under different timings and modes of entry.
Entry is profitable if the expected discounted stream of post-entry profits exceed the (sunk) investment cost required to enter the market.
These post-entry profits depend also on the expected reaction of incumbents. For them, the entry of competitors implies both a loss of market share and intensified competition.
Incumbents can act strategically in order to deter the entry of new firms and induce other incumbents to exit.
Barriers to entry Barriers to entry are those factors that allow incumbents to earn positive economic profits and make it unprofitable for newcomers to enter the industry. Two types: - Structural: don’t depend on the actions of incumbents. Are barriers due to cost advantage that arise from incumbency: o Sunk costs: Already incurred by incumbents, so a cost disadvantage for entrants.
o Preferential access to inputs. May include natural resources, distribution channels, and/or access to customers.
o Patents, compatibility, and specialized know-how o Barriers due to the presence of significant scale or scope economies with respect to the size of the market. (An entrant needs to reach the minimum efficient scale to compete effectively with incumbents).
o Barriers due to product differentiation or branding investments by incumbents: Established customer base in the presence of positive network effects or switching costs (Facebook) or pioneering products and brand recognition.
Market research suggests that pioneering products are category-defining for consumers.
1 - Strategic: are those that result when the incumbents acts in order to deter entry.
Strategic commitments (contrary to tactical moves) are decisions that have long run impact and are hard to reverse. Such that: o Expanding capacity o Investing in R&D o Branding reputation o Moving cost from marginal to fixed cost o Promise of aggressive pricing o Price matching commitments The commitments must constitute a credible threat, that is, it must alter the best response of incumbents against competitors. It’s also needed to be visible and understandable.
As you can see here, committing to a certain path of action can be profitable for the firm: A commitment strategy may have a direct and a strategic (indirect) effect on the firm’s profitability, and will generally incur a direct cost: - The direct effect is the change in the present value of profits, given that the rival’s tactics are unaffected by the commitment.
- The strategic effect is the further change in the present value of the firm’s profits due to the rival adjusting its tactics.
Barriers to entry: - Economies of scale Access to distribution Capital requirements Brand identity Switching costs Product differentiation Proprietary technology Expected retaliation Three entry conditions: - Blockaded entry: structural barriers are so high that incumbents need do nothing to deter entry.
- Deterred entry: strategic barriers are effective and are not too costly for incumbents.
- Accommodated entry: structural barriers are low and strategic barriers are ineffective or too costly for incumbents.
2 3 Strategic Commitment There are two types of commitment: - Tough (harms competitors) - Soft (benefits competitors) There are two types of strategic interaction: - Strategic complementarity: Bertrand - Strategic substitutability: Cournot - Tough commitment with Bertrand - Soft commitment with Bertrand 4 - Tough commitment with Cournot - Soft commitment with Cournot To erect strategic entry barriers, incumbents favor strategic commitments that have a negative impact on (potential) competitors. When facing competitors already present in the market, incumbents favor strategic commitments that have a positive impact on their own profits.
5 - - - Lobbying for entry barriers: Incumbent firms may also find it profitable to lobby the government to increase or forbid entry. This strategy is especially effective against foreign firm entry. This deterrence strategy is both strategic and structural.
Excess capacity: It deters entry better if: o Incumbent has a sustainable cost advantage.
o Market demand growth is slow.
o Incumbent cannot back-off from the investment in excess capacity.
Limit pricing: If the incumbent has information about the cost structure and market demand in the industry that the entrant lacks, it can deter entry by setting low prices.
This signals to the entrant that the incumbent’s costs and/or market demand may be low. As a result, post-entry competition would be intense. Limit pricing strategies are mainly consistent if the incumbent can sustain higher prices once the threat of entry has dissipated. Fierce price competition leading to the demise of rivals also allows incumbents to develop a reputation for toughness (Predatory pricing, which involves asymmetry of information between incumbents and potential entrants).
Entry Strategies - - Technological opportunity windows: The entrant may exploit asymmetries with respect to the technological commitments that have been adopted by the incumbent.
Opportunity windows open when advances in technology (or regulatory changes) allow for product innovations that the incumbent is unwilling to adopt (due to established customer base, switching costs, cannibalizing own product…) Judo economics: The entrant could exploit the incumbent’s size to her own advantage. If it can commit to a small market share in order not to present a longterm threat to the incumbent, the incumbent may prefer to accommodate her. For the incumbent, it may be more profitable to accommodate a smaller entrant than to compete aggressively to drive it out of the market. One reason may be that price reductions adopted in the process are incurred over a larger customer base.
Wars of Attrition The rents of incumbency can generate wars of attrition to force competitors out of the market. A war of attrition implies taking on temporary losses to gain market power once the war is over. Given that financial endurance is generally private information for firms, the duration of the war is uncertain and the winner may regret having engaged in it. In a war of attrition, it is critical for firms to convince their rivals that they have stronger commitments to remain in the market.
6 Structural exit barriers Barriers to exit can maintain a firm active by deterring its exit from an industry. An exiting firm will liquidate its assets or redeploy them to another market but there will be firm’s obligations which are independent of exit (labor agreements, environmental regulations).
Firm’s outside value of the assets is low, so it may prefer to remain in the market even though price is below long-run average cost. Thus, exit barriers constitute entry barriers if the firm can anticipate them.
Contestable Markets In the total absence of structural barriers the market is said to be perfectly contestable. In such a market, a monopolist would obtain zero profits (This is an example where HHI is not a good indicator). Any attempt to raise prices above average costs would attract competitors that would enter and operate in the market as long as there were profits to be made, exiting as soon as this ceased to be the case (hit-and-run entry).
Evidence on the use of entry deterring strategies - Aggressive price reductions to move down the learning curve Intensive advertising to create brand loyalty Acquiring patents Enhancing reputation for predation using announcements and other means Limit pricing Holding excess capacity 7 8 ...