Chapter 13: Advanced Topics in Business Strategy
Successful management brings about competitors.
Limit pricing to prevent entry
Manager may consider strategy such as limit pricing to prevent entry.
Limit Pricing – Strategy where an incumbent maintains a price below the monopoly in order to
prevent entry.
Theoretical basis for limit pricing: by limiting the price in level that is below the monopoly price,
the incumbent firm can force the potential entrance to get only the residual demand. In the event
where this residual demand is less than the average cost, the potential entrance will stay away
from the market.
Due to this reason, it is better if the incumbent can threaten to limit price without really do so.
The profit it gets will be monopoly profit and no companies will try to enter if they believe the
threat.
Effective limit pricing: for limit pricing to effectively prevent entry by rational competitors, the
pre-entry price must be linked to the post-entry profits of potential entrants.
Linking the pre-entry price to post-entry profits > some conditions need to be meet to ensure that
deterring entry is actually the best strategy.
Commitment Mechanisms - the incumbent can commit to produce at least the post-entry
output. This way the incumbent will actually earn more profit since if it does not commit
and let the competitor to enter, the profit will be divided among the firms in the market.
Learning curve effects - when a firm enjoys lower costs due to knowledge gained from
its past production decisions. Having learning better method of production, the incumbent
can lower its cost and then limits the price of the goods or services.
Incomplete information - due to lack of complete information, the incumbent can
purposefully limit price to make the potential entrants to reconsider their plan to enter the
market.
Reputation effects - if the incumbent has the reputation on being tough, it may prevent
entry
Dynamic consideration
If the firm manage to maintain its monopoly, then the profit will be π = [(1+i)/i] πm
Successful management brings about competitors.
Limit pricing to prevent entry
Manager may consider strategy such as limit pricing to prevent entry.
Limit Pricing – Strategy where an incumbent maintains a price below the monopoly in order to
prevent entry.
Theoretical basis for limit pricing: by limiting the price in level that is below the monopoly price,
the incumbent firm can force the potential entrance to get only the residual demand. In the event
where this residual demand is less than the average cost, the potential entrance will stay away
from the market.
Due to this reason, it is better if the incumbent can threaten to limit price without really do so.
The profit it gets will be monopoly profit and no companies will try to enter if they believe the
threat.
Effective limit pricing: for limit pricing to effectively prevent entry by rational competitors, the
pre-entry price must be linked to the post-entry profits of potential entrants.
Linking the pre-entry price to post-entry profits > some conditions need to be meet to ensure that
deterring entry is actually the best strategy.
Commitment Mechanisms - the incumbent can commit to produce at least the post-entry
output. This way the incumbent will actually earn more profit since if it does not commit
and let the competitor to enter, the profit will be divided among the firms in the market.
Learning curve effects - when a firm enjoys lower costs due to knowledge gained from
its past production decisions. Having learning better method of production, the incumbent
can lower its cost and then limits the price of the goods or services.
Incomplete information - due to lack of complete information, the incumbent can
purposefully limit price to make the potential entrants to reconsider their plan to enter the
market.
Reputation effects - if the incumbent has the reputation on being tough, it may prevent
entry
Dynamic consideration
If the firm manage to maintain its monopoly, then the profit will be π = [(1+i)/i] πm
