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Pricing Strategies and Contestable Markets - Full version

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  • 1. Pricing Strategies and Contestable Markets
  • 2. Pricing Strategies and Contestable Markets
  • 3. Pricing
  • 4. Pricing
    • Pricing – How a business approaches its pricing strategies depends on the market structure it operates in
    • Pricing can be a means of competing – not only to take customers of rivals but to prevent competition from rivals
  • 5. Price Takers
    • Price takers – have little or no control over the price they charge
    • Perfect Competition – P = MR = AR = MC = AC
      • Firms have to take the price set by the market
      • Large number of sellers – each has small market share and therefore no control over the market
      • Examples may include agricultural products, some types of financial product – stocks and shares
    • Price Leadership – Dominant firm sets price, rest have to take this price
  • 6. Price Leadership
    • Price leadership occurs where a dominant firm in an industry in which products are good substitutes is able to set price which others in the industry, on account of their smaller size, will follow
    • Examples include: Some commodity markets where there is a dominant seller, the computer software industry (Microsoft), petroleum, some forms of pharmaceutical products
    • May tend to exist in ‘micro-markets’ rather than the whole company market – e.g., no real price leadership in cereal market except for Weetabix?
  • 7. Price Fixing
    • Price Fixing – where firm/s fix prices at levels above equilibrium on account of their market power or through selling/distribution arrangements generally termed collusion. e.g. sports replica kits, children’s toys and games, steel, motor vehicles
    • Cartels – Organised price fixing – e.g. OPEC (Organisation of Petroleum Exporting Countries)
    • Price fixing is illegal – type in ‘price fixing’ into a search engine to get details of companies and organisations around the world accused of, and convicted of, price fixing!
  • 8. Price Discrimination
    • Charging different prices for the same product or service.
    • Necessity of distinctive markets with different price elasticities
    • Necessity of being able to prevent movement between the markets
    • Examples: train travel – peak time and off peak, electricity charges – off peak metering, telephone calls
  • 9. RPI minus/plus formulas (Redistribution Pricing)
    • Price regime imposed on privatised utilities to help protect the public from monopoly exploitation of essential services (Remember RPI now replaced by the CPI)
    • RPI minus – price changes in line with the annual rate of inflation minus a set percentage, e.g. RPI – 4% - if RPI was 3% implies the firm would have to look at cutting prices to consumers by 1%
    • RPI plus – imposes maximum price increases, e.g. RPI +2%, if RPI was 2% firm only able to increase prices to customers by max 4%
  • 10. Contestable Markets
  • 11. Contestable Markets
    • Theory developed by William J. Baumol, John Panzar and Robert Willig (1982)
    • Helped to fill important gaps in market structure theory
    • Perfectly contestable market – the pure form – not common in reality but a benchmark to explain firms’ behaviours
  • 12. Contestable Markets
    • Key characteristics:
      • Firms’ behaviour influenced by the threat of new entrants to the industry
      • No barriers to entry or exit
      • No sunk costs
      • Firms may deliberately limit profits made to discourage new entrants – entry limit pricing
      • Firms may attempt to erect artificial barriers to entry – e.g…
  • 13. Contestable Markets
    • Over capacity – provides the opportunity to flood the market and drive down price in the event of a threat of entry
    • Aggressive marketing and branding strategies to ‘tighten’ up the market
    • Potential for predatory or destroyer pricing
    • Find ways of reducing costs and increasing efficiency to gain competitive advantage
  • 14. Contestable Markets
    • ‘ Hit and Run’ tactics – enter the industry, take the profit and get out quickly (possible because of the freedom of entry and exit)
    • Cream-skimming – identifying parts of the market that are high in value added and exploiting those markets
  • 15. Contestable Markets
    • Examples of markets exhibiting contestability characteristics:
      • Financial services
      • Airlines – especially flights on domestic routes
      • Computer industry – ISPs, software, web development
      • Energy supplies
      • The postal service?