Week 4

Introduction
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 4

Choice of Market I
Market Attractiveness
 Process of Planning Entry

Attractiveness of Choice Choice Entry

new market entry of market of entry type strategy
 Process of Planning Entry

Attractiveness of Choice Choice Entry

new market entry of market of entry type strategy

 Market
attractiveness
 Entry barriers
 Porter‘s Five Forces
Government Potential new
regulation, entrants
taxation Entry
barriers
Competition
Bargaining Bargaining
Suppliers within the Buyers
power power
industry
Impact on
price elasticity

Substitutes
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 4

Choice of Market II
Structural Entry Barriers
 Entry Barriers
Factors that allow incumbent firms to earn positive economic profits,
while making it unprofitable for newcomers to enter the industry

Structural Entry Barriers Strategic Entry Barriers

 nature of the industry  incumbent’s aggressive action
 position of the incumbent  intended to keep the entrant
within the industry out of the industry
 Structural Entry Barriers (I/III)
Control of essential resources
 Natural resources: DeBeers / diamonds
 Supplier capacity: Minnetonka / liquid soap
 Patents: Sony and Philips / CD
 Distribution channel: Coca Cola / fast food chains
 Location: Supermarkets / top locations
 Timing: Airlines / Arrival slots at airports
 Rationing by governments: Cabs,
mobile phone networks
 Structural Entry Barriers (II/III)
Economies of scale and scope
 Minimum efficient scale: Semiconductor production
 Cost advantages of incumbents through experience or
economies of scope: Airframe production
 Structural Entry Barriers (III/III)
Marketing advantages of incumbents
 Brand loyalty: Frequent flyer programs
 Switching costs: Network markets such as mobile telephony
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 4

Choice of Market III

Strategic Entry Barriers
 Entry Barriers
Factors that allow incumbent firms to earn positive economic profits,
while making it unprofitable for newcomers to enter the industry

Structural Entry Barriers Strategic Entry Barriers

 nature of the industry  incumbent’s aggressive action
 position of the incumbent  intended to keep the entrant
within the industry out of the industry
 Strategic Entry Barriers (I/II)
The incumbent will consider deterring entry if
 The incumbent earns higher profits (despite deterring) as monopolist
than as duopolist
 The strategy changes the entrant's expectations about the nature of
post-entry competition
profits Strategic Entry Barriers (II/II)

Costs of
deterring “Costs” of
Block entry
Entry losing market
share
Accommodate
Entry

t1 t2 t3 t4

Entry
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 4

Entry Strategies I
Commitment /
Value Chain Reconfiguration
 Process of Planning Entry

Attractiveness of Choice Choice Entry

new market entry of market of entry type strategy
 Commitment (I/II)
A credible commitment of the entrant to stay in the market may stop
incumbents retaliating

Types of commitment
 High sunk cost investments
• Production capacity
• R&D
• Advertising
 Exit from other strategic market segments
and focus on entry
 Commitment (II/II)
Example: Market entry of Deutsche BA
Commitment:
Deutsche BA invests
Deutsche BA no entry entry in additional airplanes

Lufthansa no retaliation retaliation

Deutsche BA exit stay

Deutsche BA 0 4 -3 -5 -4
Lufthansa 10 4 6 6 -4
 Value Chain Reconfiguration (I/II)
 Innovators enter the market with inferior products
which appeal to price-sensitive buyers

 Incumbents ignore the threat since mainstream

customers don’t want those products

 Over time the products improve and take

large chunks of the market from incumbents

 Market leaders can hardly respond because they find

it difficult to replicate entrants’ low-cost business models
 Value Chain Reconfiguration (I/II)
Example: Bloomberg

 Began in 1981 to provide basic financial data to small investment

analysts and brokers

 Gradually improved its data offerings / analysis and substantially

disrupted competitors Dow Jones and Reuters
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 4

Entry Strategies II
Judo Economics /
Niche Market
 Judo Economics (I/IV)
Entrant

 Sets a price (pL) lower than the incumbent’s price (pH)

 Limits its capacity to serve a small proportion (xE) of the market (x)

 Signals the incumbent that it does not increase its capacity drastically
in the future
 Judo Economics (II/IV)
Incumbent

 Loses some profits by giving market share (xE) to the incumbent

 Can exclude the entrant and fight back the whole market by setting its
own price marginally lower than the entrant‘s one (pL)

 Incurs (in the short run) losses through this price reduction (pH - pL)
 Judo Economics (III/IV)
Incumbent does not attack the entrant if

pH xE < (pH – pL) x

Loss through Loss through

accepting the entrant attacking the entrant

Factors influencing the success of the entrant

 Market size / market of the incumbent (x)
 Capacity / market share of the entrant (xE)
 Price difference (pH – pL)
 Judo Economics (IV/IV)
Example: Amazon vs. Barnes & Noble
 Amazon: Enters into the online book retail in 1994
 Barnes & Noble (leading US book retailer): Does not
respond with an own online store even though
potential to exclude Amazon
 Fear that online store would trigger an online price
war and cannibalizing sales through classical
bookstores
 Amazon: Gradually dragging customers away from
classical bookstores
 Niche Market (I/III)
 The entrant focuses on a niche market
 Across the board retaliation may not be feasible for incumbent
 Niche Market (II/III)
Example: Successful niche market strategy / no retaliation

 Local phone operator NetCologone offering

local phone services in Cologne

 City-specific price reduction for local phone services

is not feasible for Deutsche Telekom
 Niche Market (III/III)
Example: Unsuccessful niche market strategy / retaliation

 Deutsche BA enters German domestic flights market

only on certain city pair routes in Germany

 Lufthansa can retaliate on particular routes

Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 4

Entry Deterrence I
Structural Entry Barriers /
Commitment
profits Motivation for Entry Deterrence

Costs of
deterring “Costs” of
Block entry
Entry losing market
share
Accommodate
Entry

t1 t2 t3 t4

Entry
 Raising Entry Barriers (I/II)
 Control of essential resources
• Ensure exclusive access to resources
• Secure more resources than is necessary for satisfying demand

 Economies of Scale / Scope

• Lower costs through larger scales
• Leverage experience advantages
• Increase technological lead
 Raising Entry Barriers (II/II)
 Marketing advantages
• Build brand loyalty
• Raise switching costs for customers
 Commitment (I/II)

Commit to an aggressive behaviour after entry

 Eliminate those moves which would lead to equilibria that are
profitable for the entrant
 Commitment (II/II)

Deutsche BA no market market

entry entry

Lufthansa status price no price

quo war war

Deutsche BA 0 -500 400

Lufthansa 1000 0 400
 Commitment (II/II)
Example

Deutsche BA no market market

entry entry

Lufthansa status price no price

quo war war
Now: Penalty of
500 to Star Alliance
if no price war
Deutsche BA 0 -500 400
Lufthansa 1000 0 400 - 500 = -100
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 4

Entry Deterrence II
Limit Pricing /
Predatory Pricing
 Limit Pricing (I/II)
 Keep price low in spite of monopoly position
 Signal to the potential entrant
• “low demand” (market may appear unattractive)
• "low cost incumbent“ (dangerous competitor)
 Works only in presence of incomplete information
 Limit Pricing (II/II)
Example: Ferries and the Eurotunnel
 The market for channel crossing was traditionally
dominated by P&O Ferries and Stena Lines
 Around the time rumour surfaced that the Dover
Eurotunnel might be realized, both reduced
Folkestone
prices by up to 50%
Calais
 After opening of the Eurotunnel, P&O and
Stena merged and raised prices again to
initial level
 Predatory Pricing (I/II)
 Charging low prices (even below marginal costs) in the current
competition
• to induce exit
• and deter future entry
 Works only in presence of incomplete information
 Predatory Pricing (II/II)
Example: UK Newspaper Industry
The Times The Independent
Price Copies Price Copies
1992 £ 0.45 382,000 £ 0.45 372,000
1993 £ 0.30 388,000 £ 0.50 333,000
1994 £ 0.20 550,000 £ 0.30 279,000
1995 £ 0.25 675,000 £ 0.35 296,000
1996 / 1997 £ 0.35 790,000 £ 0.40 260,000
1998 £ 0.35 770,000 £ 0.45 219,000
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 4

Entry Deterrence III

Pre-Emption
 Pre-Emption (I/II)
The incumbent can pre-empt an entry by
 (Over-) investing to reduce variable costs of production below the level
that would be optimal without threat of entry
 Pursuing horizontal product differentiation with greater product variety
than would be optimal without threat of entry
 Choosing locations of outlets more densely than would be optimal
without threat of entry
 Pre-Emption (II/II)
Example: Coffeehouses & the London School of Economics

Pre-Emption
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 4

Wrap Up
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich