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Lecture 13 Competition and Pricing
Motivation questions1. What motivate a company to cut price?2. Why is a price war harmful?3. 1999, Sprint announced 5 cents nighttime long-distance rate MCI matched ATT offered 7 cents all day Sprint was forced to drop price further ATT’s stock price dropped 4.7% the day of announcement. MCI stock price dropped 2.5% Sprint stock price fell 3.8%
What could have ATT done in 1999 to prevent Sprint from cutting price?
If Sprint has already cut the price, what could have been done by ATT to win the war?
Classifications of Competitive Behavior
Cooperative pricing monopolistic competition recognize a common interest
Adaptive pricing small firms take prices set by large firm
Opportunistic pricing use price to gain market share
Predatory pricing a firm use low price attempting to punish another firm or drive
it out of business Limit pricing
Discourage the entry of potential competitors
Understanding Pricing Game Incentives for undercutting price
Evil intention extra market share and opportunistic profit if not immediately
retaliated by competitors especially true for industries with high fixed cost and peak
seasons
Good intentions A firm strategically changes the way business is done
Office Depot A firm offers additional feature without increasing price A firm misreads the change in market share A firm overreacts to a competitor’s limited and focused price
reduction with an across-the-board price reduction
If you cut price for good intentions, make sure your competitors do not misinterpret your intentions
Price war is “negative-sum” game Economic disaster
Difficult to increase profits by reducing price Coca-Cola, 1% reduction means $20million reduction in operating profit
No gain if immediately retaliated by competitors Cutting price rarely drives competitors out of business
Psychological trauma Lower consumer reference price Reduce consumer sensitivity to quality Train loyal consumers to switchers
Depending on how competitors interpret your move, your price cut that boost sales today will radically change the industry you compete tomorrow! That change is forever.
“Negative-sum game” Illustrated
Prisoner’s dilemma Prisoner A
Confess Does not confess
Prisoner B
Confess
Does not confess
Winning “negative-sum” battles requires
management forward-looks future behavior of competitors and consumers and resulting profitability.
a process of 3 steps: Step 1: make long-term plans (to prepare for
future price war) Step 2: diplomatically communicate with your
competitors (to avoid price war) Step 3: wisely choose confrontation (to win price
war)
How to Fight the Price War?
Step 1: develop long-term plans to prepare for price war
Setup market intelligence to understand competitors Information on competitors
What: price structure, transaction price, history of price moves, cost, capacity
How: sales force, favored consumers, trade associations, list future prices, ghost shop, distributors, technical consultants, securities analysts
Information on demand What: future growth of the market
Develop price leadership Will be discussed in Federated Industries
Build up sustainable competitive advantages
Step 2: legally “communicate” with your competitors to avoid price war
Reveal that your intention of price cut is temporary and not threatening
excess inventory over capacity future growth of the market introduction of a simple version of the existing product
Reveal your capability of fighting a price war cost advantage future expansion plan willingness to fight back
Winn-Dixie, Big Star and Food Lion
Pre-announce price increases American Airline
Tools for competitive signaling Match price cut immediately A discount mimic exactly your competitor’s offer Test the water (American Airline)
Announce new, patented manufacturing process Japanese manufacturer
Announce intentions, capabilities and future plans Show willingness and ability to defend
1990s Chrysler minivan Publicize a competitor’s opportunism Legal suit Price structures carry signaling messages
Bundled price Two-part price that reward additional business End-of-year rebates rather than quantity discount Functional discounts
Step 3: wisely choose confrontation (to win price war)Non-price actions Focus on the other 3 Ps.
1997 Malaysian Ritz-Carlton Alert customers to risk poor quality
Fedex “absolutely and positively be there”
Price-related actions Change consumer choice
1980, McDonald “value meal” Cut price selectively
Sun Country Airlines Develop a fighting brand
1990, Kao Corporation and 3M Offer new package and lock in future sales
“buy one, get one free”
Match the price cut Match price cut but protect profit
HP, IBM, “fee PCS” Do it quickly to avoid future cut
Retreat It may be wise to cede market share
1980s, Intel dropped DRAM, Taiwan1990s, 3M withdrew from videotape
General principle, response should be focused and in kind (tit-for-tat). When competitors move back to rational price, show immediate support.
When is it profitable to initiate a price cut?
Aggressive (opportunistic) pricing is profitable when incremental cost advantage
Wal-Market, Southwest, Dell products attractive to a small share of market
ATT vs. Sprint will not catch immediate attention
Federated Industries related products can be cross-sold in the future
Microsoft demand is still growing at the product growth stage have excess capacity (keep excess capacity)
Key: justify your price cut to avoid price war
Take-aways from today’s lecture
Price war is a “negative-sum” game. In the long-run, it hurts every players in the industry.
Winning price war requires Step 1: develop long-term plans (to prepare for future
price war) Step 2: diplomatically communicate with your competitors
(to avoid price war) Step 3: wisely choose confrontation (to win price war)
Decision on initiating or matching price cut should be made based on long-term consequence
Next Lecture
Product Lifecycle pricing
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