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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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Predatory Pricing and 'eputation
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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Predatory Pricing and 'eputation
#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.
All rights reserved. Reproduction or translation of this work
beyond that permitted in section 117 of the 1976 Unitedtates !opyright Act without e"press permission from thecopyright owner is unlawful. Re#uests for further informationshould be addressed to the $ermissions %epartment& 'ohn(iley ) ons& *nc. +he purchaser may make back,up copies
for his-her own use only and not for distribution or resale.+he $ublisher assumes no responsibility for errors& omissions&or damages caused by the use of these programs or from theuse of the information herein.