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Discussion Board – Oligopolistic Industries

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An oligopoly is characterized by a relatively small number of firms offering a similar product or service. Oligopoly products may be branded, as in soft drinks, cereals, and athletic shoes, or unbranded, as in crude oil, aluminum, and cement. The main distinction of oligopoly is that the number of firms is small enough that actions by any individual firm on price, output, product style, quality, introduction of new models, and terms of sale has an impact on the sales of other firms in the industry. Review the Table 12.1 (pg. 416), select a dominant single firm, duopoly firm, and triopoly firm and discuss if you foresee any weaknesses in the three firms you selected that would allow entrance into this market or if one of the firm has enough strength to become a monopoly?

Note: Find Table 12.1 in the attached PPT.

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Managerial Economics
Applications, Strategies and Tactics,

James R. McGuigan

R. Charles Moyer

Frederick H. deB. Harris

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

PART IV – PRICING & OUTPUT DECISIONS:
STRATEGY AND TACTICS
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Chapter 12 –
Price and Output Determination:
Oligopoly

Chapter 12 – Price & Output Determination: Oligopoly Overview (1 of 1)
OLIGOPOLISTIC MARKET STRUCTURES
INTERDEPENDENCIES IN OLIGOPOLISTIC INDUSTRIES
CARTELS AND OTHER FORMS OF COLLUSION
PRICE LEADERSHIP
THE KINKED DEMAND CURVE MODEL
AVOIDING PRICE WARS

Ch 12 – Oligopolistic Market Structures
(1 of 1)
An oligopoly is characterized by a relatively small number of firms offering a similar product or service
Oligopoly products may be branded or unbranded
The number of firms is small enough that actions by any one firm on price, output, etc. have a perceptible impact on the sales of the others
Each firm knows that any new price cut or large promotional campaign is likely to evoke a countermove from its rivals
Rival response expectations are the key to firm-level analysis
If rival firms are expected to match price increases and price cuts, a share-of-the market demand curve may illustrate the sales response to the pricing initiatives of the firm (See Figure 12.1)

Figure 12.1 –
Rival Response Expectations Determine Firm Demand
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Figure 12.2 Browser Market Shares
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Ch 12 – Oligopolistic Market Structures
Oligopoly in the U.S.: Relative Market Shares (1 of 1)
Much of U.S. industry is best classified as oligopolistic in structure with a wide range of industry configurations, (Table 12.1)
At one extreme are dominant single firms in the markets for razors, beer, etc.
In crackers, handsets, etc. two firms dominate
Sales in tires, U.S. auto & truck markets are dispersed across 6-8 firms
Market shares are more dispersed in telecom equipment and pharmaceuticals

Table 12.1 – Largest U.S. Market Shares in Oligopolistic Industries
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Table 12.2 – Market Share Distributions Over Time in Airlines, Cereals, and Wide-Bodied Aircraft
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Figure 12.3 – The Relative Sizes of Competitors in the Auto Rental and Gasoline Industries
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Ch 12 – Interdependencies in Oligopolistic Industries
The Cournot Model (1 of 1)
One standard approach to the interdependency problem among oligopolists is merely to ignore it, for a firm to assume that its competitors will act as if it does not exist
Because of the wide scope of oligopoly industry configurations in Table 12.1, several simplifying models have been used to describe oligopolists’ competitive behavior regarding price, output, etc.
The Cournot oligopoly model asserts that each firm, in determining its profit-maximizing output level assumes that the other firm’s output will not change

Ch 12 – Cartels and Other Forms of Collusion
(1 of 1)
Oligopolists sometimes reduce the inherent risk of being so interdependent by either formally or informally agreeing to cooperate or collude in decision-making; such agreements are called cartels
Cartel – A formal or informal agreement among firms in an oligopolistic industry that influences such issues s prices, total industry output, market shares, and the division of profits
In general, collusive agreements are illegal in the U.S. and Europe, but some exceptions exist
Prices and quotas of some agricultural products are set by grower cooperatives
The IATA airlines flying transoceanic routes jointly set uniform prices for these flights
Ocean shipping rates are set by hundreds of collusive conferences on each major route
Illegal collusive arrangements also arise from time to time

Ch 12 – Cartels and Other Forms of Collusion
Factors Affecting the Likelihood of Successful Collusion (1 of 2)
Number and Size Distribution of Sellers
Collusion is less difficult as the number of firms involved decreases
Product Heterogeneity
Products that are alike are homogenous, and price is the only distinction that matters; for heterogeneous (differentiated) products, cooperation is more difficult
Cost Structures
The more cost functions differ among competing firms, the more difficult it will be
Size and Frequency of Orders
Effective collusion is more likely when orders are small, frequent, and received regularly, as in the purchase of autos

Ch 12 – Cartels and Other Forms of Collusion
Factors Affecting the Likelihood of Successful Collusion (2 of 2)
Threat of Retaliation
An oligopolistic firm will be less tempted to grant secret price concessions to selected customers if it feels that other cartel members would detect those price reductions and then retaliate
Percentage of External Output
Most cartels contain the seeds of their own destruction
rising prices and profits attract the entry of new competitors
any increase in supply from outside the cartel means that larger restrictions on output must be imposed on cartel members in order to sustain price

Ch 12 – Cartels and Other Forms of Collusion
Cartel Profit Maximization and the Allocation of Restricted Output (1 of 1)
Under legal cartels & secret collusive agreements, firms attempt to increase prices and profits above the level that would prevail in the absence of collusion
The profit-maximization solution for a two-firm cartel, E and F, is shown graphically in Figure 12.4
If the cartel maximizes its total profits, the market share (quota)for each firm should be set where marginal cost of all firms is identical and the industry (summed) MC = MR
The central problem for cartels is in monitoring these quotas, detecting violations and effectively enforcing punishments
As a result, most cartels are unstable
The longevity of OPEC and the DeBeers diamond cartels is exceptional

Figure 12.4 –
Price-Output Determination for a Two-Firm Cartel
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Figure 12.5 –
How OPEC III Production Quotas Affected Crude Oil Prices
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Figure 12.6 – Saudi Arabian Crude Oil Production
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Figure 12.7 – Proven Oil Reserves
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Figure 12.8 –
Components of the Price of Gasoline per Gallon (1990-2009)
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Ch 12 – Cartels and Other Forms of Collusion
Cartel Analysis: Algebraic Approach (1 of 3)
The profit-maximizing price and output levels for a two-firm cartel can be determined algebraically when the demand and cost functions are given:

Ch 12 – Cartels and Other Forms of Collusion
Cartel Analysis: Algebraic Approach (2 of 3)

Ch 12 – Cartels and Other Forms of Collusion
Cartel Analysis: Algebraic Approach (3 of 3)

Table 12.3 – Comparisons of Pricing, Output, and Profits for Siemens & Thomson
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Ch 12 – Price Leadership
(1 of 1)
Price leadership – A pricing strategy followed in many oligopolistic industries. One firm normally announces all new price changes. Either by an explicit or by an implicit agreement, other firms in the industry regularly follow the pricing moves of the industry leader
Barometric Price Leadership
One firm announces a change in price that it hopes will be accepted by others
The leader must, however, be reasonably correct in its interpretation of changing demand and cost conditions
The barometric price leader merely initiates a reaction to changing market conditions that other firms find in their best interests to follow

Ch 12 – Price Leadership
Dominant Firm Price Leadership (1 of 1)
One firm establishes itself as the leader because of its larger size, customer loyalty, or lower cost structure in relation to others
The leader may then act as a monopolist in its segment of the market
The incentive for followers to accept the established price may be a fear of cutthroat retaliation from a low-cost dominant firm, or it may be simply a convenience
The price-output solution for the dominant-firm model is shown in Figure 12.9
The dominant firm maximizes its profits by setting price and output where marginal cost equals marginal revenue

Figure 12.9 –
Price-Output Determination for the Dominant Firm
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Ch 12 – The Kinked Demand Curve Model
(1 of 1)
Sometimes when an oligopolist cuts its prices, competitors quickly feel the decline in their sales, and are forced to match the price reduction
Or, if one firm raises its prices, competitors gain customers by maintaining their original prices, and have little motivation to match a price increase
The demand curve facing an individual oligopolist would be far more elastic for price increases than for price decreases (Figure 12.10)
This model explains why stable prices exist in some oligopolistic industries
But the kinked demand model is incomplete in that it offers no reason why the prevailing price level, rather than some other one, is chosen

Figure 12.10 – The Kinked Demand Curve Model
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Ch 12 – Avoiding Price Wars
(1 of 1)
To sustain profitability, oligopoly firms must avoid discounting tactics in their high-margin business
The ready-to-eat (RTE) Cereal, beer, camera film, DVD industries & more have experienced classic price wars
Growing the Market
One key to avoiding price wars is to attempt to grow the market
Pepsi cannot hope to get rid of Coke
Each rival must anticipate aggressive discounting designed to attract the other firm’s customers
It is better to maintain high prices and focus on opening new markets

Ch 12 – Avoiding Price Wars
Customer Segmentation with Revenue Management (1 of 1)
If low-cost new entrants attack a major airline, one effective response involves matching prices to a targeted customer segment and controlling how much capacity is released for sale to that segment
“fencing” restrictions such as 7-day advance-purchase requirements, and Saturday night stayovers prove crucial in segmenting the price-sensitive discretionary traveler from the regular business expense account customer
Incumbent carriers can “meet the competition” in these restricted fare classes while reserving sufficient capacity for those who desire to pay for the reliability, convenience, and change-order responsiveness of business-class and full-coach seats
Established competitors can maintain high prices on segments & routes, etc.

Ch 12 – Avoiding Price Wars
Reference Prices and Framing Effects (1 of 1)
Product line extensions can reduce gainshare price discounting by providing reference prices and framing effects that help sell the mid-range product at undiscounted prices
Consumers of unbranded products typically remember the last price they encountered
Branded products, however, trigger much longer reference pricing
Discounting with a major branded item tends to etch in the customer’s mind a new lowball price that can be expected thereafter for months or years’
Therefore, better to introduce a super-premium product offered at price points well above your traditional product; loyal customers will remember

What Went Right? ● What Went Wrong?
Good-Better-Best Product Strategy at Marriott Corp & Kodak
Marriott responded to fierce price competition by introducing upscale, high-quality, mid-range, and down-market product lines to its customers.
Length of stay, proximity to the central business district, and room type effectively segmented Marriott’s customer base
Marriott has no problem getting a substantial price premium for hotel rooms with sitting areas in central business districts & convention hotels
In the late 1990s, Kodak pursued a similar concept with discounted Funtime Film and the Kodak disposable camera
Disposable cameras for everyday use made this film highly accessible
Kodak’s Royal Gold film provided exceptional picture resolution in many lighting conditions, and could memorialize subtleties of expression, at a premium price
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© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Ch 12 – Avoiding Price Wars
The Role of Innovation (1 of 1)
Rather than matching price cuts, a higher-priced brand can highlight conspicuous product innovations
Sony’s Mavica was an easy-to-use point-and-shoot digital camera that recorded images onto thumb drives, which popped out of the camera and loaded into any PC for easy editing, storing and printing
While competitor Kodak was improving picture resolution to justify expensive and complicated home printer hardware peripherals using Kodak chemicals and paper, Sony simplified the prices and increased customer value.
Mavica earned a premium price relative to its competitors

Figure 12.11 –
Segmented Oligopoly with Extreme Brand Loyalty
© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
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Ch 12 – Avoiding Price Wars
Matching Price Cuts with Increased Advertising (1 of 1)
Perhaps the best way to avoid a price was is to not start one
If someone else starts a price war, often the best response is simply to match the competition and then accentuate non-price elements of the marketing mix by increasing services or advertising
A final key to avoiding price wars comes through the tactical insights often available from game theory analysis:
Being able to identify a rival’s payoffs using competitor surveillance helps predict the competitor’s response to one’s own price cuts
In other circumstances, cooperative high-price outcomes may arise out of mutual interest
Recognizing the detailed structure of the pricing “game” can be a first step in altering the competitive environment

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