Lecture 13 Competition and Pricing.ppt

Lecture 13 Competition and Pricing Motivation questions What motivate a company to cut price? Why is a price war harmful? 1999, Sprint announced 5 cents nighttime long-distance rate MCI matched ATT offered 7 cents all day Sprint was forced to drop price further ATT’s stock price dropped 4.7% the day of announcement. MCI stock price dropped 2.5% Sprint stock price fell 3.8% What could have ATT done in 1999 to prevent Sprint from cutting price? If Sprint has already cut the price, what could have been done by ATT to win the war? Classifications of Competitive Behavior Cooperative pricing monopolistic competition recognize a common interest Adaptive pricing small firms take prices set by large firm Opportunistic pricing use price to gain market share Predatory pricing a firm use low price attempting to punish another firm or drive it out of business Limit pricing Discourage the entry of potential competitors Understanding Pricing Game Incentives for undercutting price Evil intention extra market share and opportunistic profit if not immediately retaliated by competitors especially true for industries with high fixed cost and peak seasons Good intentions A firm strategically changes the way business is done Office Depot A firm offers additional feature without increasing price A firm misreads the change in market share A firm overreacts to a competitor’s limited and focused price reduction with an across-the-board price reduction If you cut price for good intentions, make sure your competitors do not misinterpret your intentions Price war is “negative-sum” game Economic disaster Difficult to increase profits by reducing price Coca-Cola, 1% reduction means $20million reduction in operating profit No gain if immediately retaliated by competitors Cutting price rarely drives competitors out of business Psychological trauma Lower consumer reference price Reduce consumer sensitivity to quality