Pricing Strategies and Contestable Markets - Full version


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Pricing Strategies and Contestable Markets - Full version

  1. 1. Pricing Strategies and Contestable Markets
  2. 2. Pricing Strategies and Contestable Markets
  3. 3. Pricing
  4. 4. Pricing <ul><li>Pricing – How a business approaches its pricing strategies depends on the market structure it operates in </li></ul><ul><li>Pricing can be a means of competing – not only to take customers of rivals but to prevent competition from rivals </li></ul>
  5. 5. Price Takers <ul><li>Price takers – have little or no control over the price they charge </li></ul><ul><li>Perfect Competition – P = MR = AR = MC = AC </li></ul><ul><ul><li>Firms have to take the price set by the market </li></ul></ul><ul><ul><li>Large number of sellers – each has small market share and therefore no control over the market </li></ul></ul><ul><ul><li>Examples may include agricultural products, some types of financial product – stocks and shares </li></ul></ul><ul><li>Price Leadership – Dominant firm sets price, rest have to take this price </li></ul>
  6. 6. Price Leadership <ul><li>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 </li></ul><ul><li>Examples include: Some commodity markets where there is a dominant seller, the computer software industry (Microsoft), petroleum, some forms of pharmaceutical products </li></ul><ul><li>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? </li></ul>
  7. 7. Price Fixing <ul><li>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 </li></ul><ul><li>Cartels – Organised price fixing – e.g. OPEC (Organisation of Petroleum Exporting Countries) </li></ul><ul><li>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! </li></ul>
  8. 8. Price Discrimination <ul><li>Charging different prices for the same product or service. </li></ul><ul><li>Necessity of distinctive markets with different price elasticities </li></ul><ul><li>Necessity of being able to prevent movement between the markets </li></ul><ul><li>Examples: train travel – peak time and off peak, electricity charges – off peak metering, telephone calls </li></ul>
  9. 9. RPI minus/plus formulas (Redistribution Pricing) <ul><li>Price regime imposed on privatised utilities to help protect the public from monopoly exploitation of essential services (Remember RPI now replaced by the CPI) </li></ul><ul><li>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% </li></ul><ul><li>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% </li></ul>
  10. 10. Contestable Markets
  11. 11. Contestable Markets <ul><li>Theory developed by William J. Baumol, John Panzar and Robert Willig (1982) </li></ul><ul><li>Helped to fill important gaps in market structure theory </li></ul><ul><li>Perfectly contestable market – the pure form – not common in reality but a benchmark to explain firms’ behaviours </li></ul>
  12. 12. Contestable Markets <ul><li>Key characteristics: </li></ul><ul><ul><li>Firms’ behaviour influenced by the threat of new entrants to the industry </li></ul></ul><ul><ul><li>No barriers to entry or exit </li></ul></ul><ul><ul><li>No sunk costs </li></ul></ul><ul><ul><li>Firms may deliberately limit profits made to discourage new entrants – entry limit pricing </li></ul></ul><ul><ul><li>Firms may attempt to erect artificial barriers to entry – e.g… </li></ul></ul>
  13. 13. Contestable Markets <ul><li>Over capacity – provides the opportunity to flood the market and drive down price in the event of a threat of entry </li></ul><ul><li>Aggressive marketing and branding strategies to ‘tighten’ up the market </li></ul><ul><li>Potential for predatory or destroyer pricing </li></ul><ul><li>Find ways of reducing costs and increasing efficiency to gain competitive advantage </li></ul>
  14. 14. Contestable Markets <ul><li>‘ Hit and Run’ tactics – enter the industry, take the profit and get out quickly (possible because of the freedom of entry and exit) </li></ul><ul><li>Cream-skimming – identifying parts of the market that are high in value added and exploiting those markets </li></ul>
  15. 15. Contestable Markets <ul><li>Examples of markets exhibiting contestability characteristics: </li></ul><ul><ul><li>Financial services </li></ul></ul><ul><ul><li>Airlines – especially flights on domestic routes </li></ul></ul><ul><ul><li>Computer industry – ISPs, software, web development </li></ul></ul><ul><ul><li>Energy supplies </li></ul></ul><ul><ul><li>The postal service? </li></ul></ul>