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Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
Competitive Market Analysis Week 10
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Competitive Market Analysis Week 10

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  • Simultaneous: Firm1 passive, Firm 2 Aggressive Sequential: Firm 1 Aggressive knowing that Firm 2 will remain passive
  • Transcript

    • 1. Competitive Market Analysis Week 10 Competition and Commitment Chapters 8 and 9
    • 2. Week 10 Outline <ul><li>Chapter 8: Competition and equilibrium </li></ul><ul><ul><li>Review problems </li></ul></ul><ul><ul><li>Concluding on chapter 8: Structure and Price Competition </li></ul></ul><ul><li>Chapter 9: Strategic Commitment </li></ul><ul><ul><li>Defining Commitment </li></ul></ul><ul><ul><li>Commitment and competition </li></ul></ul><ul><ul><li>Flexibility and Options </li></ul></ul><ul><ul><li>More problems ! </li></ul></ul>
    • 3. Problems 9, 10, 11 from Chapter 8
    • 4. Herfindahl Index (Q9a) Market shares: Coke—40%; Pepsi—30%; 7-Up—10%; Dr. Pepper—10%; all other brands—10%. .4 2 + .3 2 + .1 2 + .1 2 = Herfindahl index = .16 + .09 + .01 + .01 = 0.27 If Pepsi acquired 7-Up: .4 2 + .4 2 + .1 2 = Herfindahl index = .16 + .16 + .01 = 0.33 Assuming here that market shares of firms in the industry do not change as a result of the merger of two players (Pepsi and 7-Up).
    • 5. Q10:Cournot Equilibrium Looking at firm 1 only <ul><li>Market: P = 100 – Q P = 100 – Q 1 – Q 2 </li></ul><ul><li>TR 1 : (100 - Q 1 - Q 2g ) x Q 1 </li></ul><ul><li>∏ 1 : TR 1 – TC 1 </li></ul><ul><li>∏ 1 : (100 - Q 1 - Q 2g ) x Q 1 – 40Q 1 </li></ul><ul><li>∏ 1 : 60 Q 1 – Q 1 2 – Q 1 Q 2g </li></ul><ul><li>d∏ 1 /dQ 1 : 60 – 2 Q 1 - Q 2g = 0 60 – Q 2g = 2 Q 1 Q 1 = 30 - .5Q 2g </li></ul>
    • 6. Q10: Cournot Equilibrium Solving for Q 1 and Q 2 <ul><li>Q 1 = 30 - .5Q 2g </li></ul><ul><li>Q 2 = 30 - .5Q 1g because of symmetry </li></ul><ul><li>At equilibrium Q 1 = Q 1g and Q 2 = Q 2g </li></ul><ul><li>Q 1 = 30 - .5( 30 - .5Q 1 ) </li></ul><ul><li>Q 1 = 30 – 15 + .25Q 1 </li></ul><ul><li>Q 1 - .25Q 1 = 15 </li></ul><ul><li>.75Q 1 = 17.5 </li></ul><ul><li>Q 1 = 20 thus P 1 = 60, Profit = 400 Don’t forget (60-40)x 20 </li></ul>
    • 7. Q11:Bertrand Price Competition Horizontal Differentiation <ul><li>Q x = 100 – 2P x + P y MC= 20 </li></ul><ul><li>Q y = 100 – 2P y + P x MC= 20 </li></ul><ul><li>∏ x = (P x – 20) (100 – 2P x + P y ) = 100P x – 2P x 2 + P x P y - 2000 + 40P x – 20P y = 140 P x –2 P x 2 + P x P y – 2000 – 20P y </li></ul><ul><li>d∏ x /dp = 140 – 4 P x + P y = 0 </li></ul><ul><li>4 P x = 140 + P y or P x = 35 + . 25P y </li></ul>
    • 8. Q11: Bertrand Price Competition Horizontal Differentiation (2) <ul><li>P x = 35 + . 25P y </li></ul><ul><li>P y = 35 + . 25P x </li></ul><ul><li>P x = 35 + .25(35 + .25P x ) </li></ul><ul><li>P x = 35 + 8.75 + .0625P x </li></ul><ul><li>.9375P x = 43.75 </li></ul><ul><li>P x = 46.67 </li></ul><ul><li>Unit Profit x = 26.67, given MC = 20 </li></ul>
    • 9. Q11: Bertrand Price Competition Horizontal Differentiation (3) <ul><li>Given </li></ul><ul><ul><li>P x = 46.67, MC = 20 </li></ul></ul><ul><ul><li>Unit Profit = 26.67 </li></ul></ul><ul><li>Q x = 100 – 2P x + P y = 100 – 93.34 + 46.67 = 53.33 </li></ul><ul><li>Profit x = (46.67- 20) x 53.33 = 1422.31 </li></ul>
    • 10. Structure: Number of firms (1) <ul><li>MES: U-shaped or L-shaped </li></ul><ul><li>High initial sunk costs </li></ul><ul><li>Sunk costs: </li></ul><ul><ul><li>Production (B2B) </li></ul></ul><ul><ul><li>Advertising and Branding (B2C) </li></ul></ul><ul><li>Differentiation </li></ul>
    • 11. Structure: Number of firms (2) <ul><li>Market demand Q* </li></ul><ul><li>Minimum efficient scale q** </li></ul><ul><li>N = Q*/q** </li></ul>q** q**
    • 12. Structure: Pricing Range (1) Monopoly  MR = MC Perfect Competition  P = MC D = AR MR MC Q m Q pc AC P m P pc Market Demand and Firm Cost Structure
    • 13. Structure: Pricing (2) <ul><li>Leonard Weiss </li></ul><ul><ul><li>Higher prices in concentrated markets </li></ul></ul><ul><ul><li>When top three gasoline retailers had market share > 60%, prices were 5% higher compared to other markets where top three retailers had a 50% share </li></ul></ul>
    • 14. Structure: Pricing (3) <ul><li>Bresnahan and Reiss </li></ul><ul><ul><li>Service industries (doctors, tire dealers, plumbers....) </li></ul></ul><ul><ul><li>Market entry threshold </li></ul></ul><ul><ul><li>E n = Minimum population to support n service providers </li></ul></ul><ul><ul><li>E 2 is about 4 times E 1 (doubled demand to compensate for reduced prices) </li></ul></ul><ul><ul><li>E 3 – E 2 > E 2 – E 1 (competition more intense with 3) </li></ul></ul><ul><ul><li>E 4 – E 3 = E 3 – E 2 (price competition is close to max.) </li></ul></ul><ul><ul><li>Three firms are sufficient for optimal price competition </li></ul></ul>
    • 15. Strategic Commitment
    • 16. Game Theory (Nash Equilibrium) Payoffs matrix for a simple strategy What is Nash equilibrium with simultaneous and independent strategies? What is Nash equilibrium if Firm 1 takes leadership and moves first? Firm 2 Aggressive Passive Firm 1 Aggressive 12.5; 4.5 16.5; 5.0 Passive 15.0; 6.5 18.0; 6.0
    • 17. <ul><li>Sending clear signals to competitors </li></ul><ul><li>Signals: </li></ul><ul><ul><li>Visible </li></ul></ul><ul><ul><li>Understandable </li></ul></ul><ul><ul><li>Credible (no bluff and irreversible) </li></ul></ul><ul><li>Example 9.1: Loblaw versus Wal-Mart Canada </li></ul>Strategic Commitment
    • 18. Marchionne's grand plan is to create a global car giant by combining the best pieces of Fiat and Chrysler. The strategy makes sense on paper .... &quot;Chrysler can make it,&quot; says Hall. &quot;The question is, how committed is Fiat to saving Chrysler?&quot;
    • 19. Strategic Decisions <ul><li>Tough Commitments (No Matter What) </li></ul><ul><ul><li>Cournot: Capacity expansion </li></ul></ul><ul><ul><li>Bertrand: Price reduction </li></ul></ul><ul><li>Soft Commitments (Else) </li></ul><ul><ul><li>Cournot: Capacity adjustment </li></ul></ul><ul><ul><li>Bertrand: Price adjustment </li></ul></ul>
    • 20. Strategic Substitution in a Cournot Equilibrium Q 2 Q 1 R 1b R 2 R 1a b a Firm 1: Tough Commitment
    • 21. Strategic Complement in a Bertrand Equilibrium P 2 P 1 R 2 R 1b R 1a a b Firm 1: Tough Commitment
    • 22. No Differentiation P 2 P 1 R 1-2 MC Monopoly
    • 23. Product Differentiation in Monopolistic Competition P 2 P 1 R 2 R 1b R 1a a b P 2 P 1 R 2 R 1b R 1a a b
    • 24. Analysing Commitments <ul><li>Positioning (NPV) </li></ul><ul><ul><li>Benefit, Creation of value? </li></ul></ul><ul><li>Sustainability (NPV and sensitivity) </li></ul><ul><ul><li>Competitors responses & entrants </li></ul></ul><ul><li>Flexibility (Decision Theory) </li></ul><ul><ul><li>Incorporating uncertainties </li></ul></ul><ul><li>Judgement (Track Record) </li></ul><ul><ul><li>Organisational factors (types I and II errors) </li></ul></ul>
    • 25. Example of NPV Analysis
    • 26. Cournot Equilibrium Chapter 8, Q 10 <ul><li>∏ 1 : (100 - Q 1 - Q 2g ) x Q 1 – 40Q 1 </li></ul><ul><li>∏ 2 : (100 - Q 2 - Q 1g ) x Q 2 – 40Q 2 </li></ul><ul><li>Q 1 and Q 2 = 30 - .5Q 2g = 20 </li></ul><ul><li>P 1 and P 2 = (100 – 20 -20) = 60 </li></ul><ul><li>Profit (60 – 40) x 20 = 400 </li></ul><ul><li>Imagine that F1 makes an investment ($1000) with a 3 three year horizon and reduces its MC to 20 from 40. New profit is (60 – 20) * 20 = 800? </li></ul>
    • 27. Changes in Cournot Equilibrium <ul><li>∏ 1 : (100 - Q 1 - Q 2g ) x Q 1 – 20Q 1 </li></ul><ul><li>∏ 2 : (100 - Q 2 - Q 1g ) x Q 2 – 40Q 2 </li></ul><ul><li>MR 1 = 80 – 2Q 1 –Q 2g </li></ul><ul><li>MR 2 = 60 – 2Q 2 –Q 1g </li></ul><ul><li>Opt. Q 1 = 40 – .5Q 2 </li></ul><ul><li>Opt. Q 2 = 30 – .5Q 1 </li></ul><ul><li>Q 1 = 33.3 and Q 2 = 13.3 </li></ul><ul><li>P 1 = 100 – 33.3 - 13.3 = 53.4 </li></ul><ul><li>Profit Firm 1= 1,112 </li></ul><ul><li>Profit Firm 2= 178 </li></ul><ul><li>Additional profit for Firm 1 = 712 </li></ul>
    • 28. Decision Analysis Changes in Cournot Equilibrium <ul><li>Additional profit = 712 </li></ul><ul><li>MC reduction from 40 to 20 </li></ul><ul><li>Upfront investment = 1000 </li></ul><ul><li>Investment horizon = 3 years </li></ul><ul><li>Hurdle rate = 20% </li></ul><ul><li>What is the PV? Go, No Go? </li></ul>
    • 29. Decision Analysis <ul><li>PV Year 1 (712) = 593 </li></ul><ul><li>PV Year 2 (712) = 494 </li></ul><ul><li>PV Year 3 (712) = 412 1,499 </li></ul><ul><li>Upfront investment 1,000 </li></ul><ul><li>NPV = 499 </li></ul><ul><li>PV = FV/(1+r) n </li></ul><ul><li>NPV = -I 0 -  n [FV/(1+r) n ] </li></ul>
    • 30. Uncertainty <ul><li>Sunk cost 100M </li></ul><ul><li>Favourable outcome 300M (Revenue) </li></ul><ul><li>Unfavourable outcome 50M (Revenue) </li></ul><ul><li>Probabilities .50/.50 </li></ul><ul><li>Expected value? </li></ul>
    • 31. Uncertainty <ul><li>300M x .5 = 150M </li></ul><ul><li>50M x .5 = 25M </li></ul><ul><li>Expected Revenue 175M </li></ul><ul><li>Minus Investment - 100M </li></ul><ul><li>Expected value 75M </li></ul>
    • 32. Flexibility <ul><li>Delaying the investment decision by one year ... then the firm will know for sure </li></ul><ul><li>One year from now (T + 1) $300 - $100 = 200 x .5 = $100 $No go x .5 = $ 0 $100 </li></ul><ul><li>Discount rate at 10% (T + 1) </li></ul><ul><li>$100/1.10 = $91 Vs $75 </li></ul><ul><li>Reminder PV =  FV/(1+R) n NPV = -I 0 +  FV/(1+R) n </li></ul>
    • 33. Flexibility (cont.) Situation 1 = Invest 100 now Situation 2 = Delay T + 1 Pr. 5 Favorable Outcome 300-100 Pr. 5 Unfavorable Outcome 50 - 100 E(Val.) = 100 E(Val.) = - 25 E(Val.) = 75 Pr. 5 Favorable Outcome 300 - 100 E(Val.) = 100 Pr. 5 Unfavorable Outcome No Go E(Val.) = 0 E(Val.) = 100 However, this 100 is at T+1 PV = (1+r) n FV PV = 1.10 x 100 = 91 Vs 75
    • 34. Time Horizon T 0 T 1 -100 NPV =75 -100 FEV(100) NPV =91
    • 35. Can you beat a fourth-year undergrad? <ul><li>If you think so, click here Can you beat a fourth-year undergrad? </li></ul><ul><li>And for optional brownie points, file your answers in the SM template: http://www.surveymonkey.com/s.aspx?sm=iz4b_2fUhYOsPLQ9fSs0YiLQ_3d_3d </li></ul>
    • 36. Wrap up <ul><li>Market structure, Number of firms and Price competition </li></ul><ul><li>Commitment </li></ul><ul><li>Reactions </li></ul><ul><li>Analysing commitment </li></ul>

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