Pricing Strategies and Contestable Markets

1. Pricing Strategies and Contestable Markets

2. Pricing Strategies and Contestable Markets

3. Pricing

4. Pricing • Pricing – How a business approaches its pricing strategies depends on the market structure it operates in • Pricing can be a means of competing – not only to take customers of rivals but to prevent competition from rivals

5. Price Takers • Price takers – have little or no control over the price they charge • Perfect Competition – P = MR = AR = MC = AC • Firms have to take the price set by the market • Large number of sellers – each has small market share and therefore no control over the market • Examples may include agricultural products, some types of financial product – stocks and shares • Price Leadership – Dominant firm sets price, rest have to take this price

6. Price Leadership • 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 • Examples include: Some commodity markets where there is a dominant seller, the computer software industry (Microsoft), petroleum, some forms of pharmaceutical products • 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?

7. Price Fixing • 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 • Cartels – Organised price fixing – e.g. OPEC (Organisation of Petroleum Exporting Countries) • 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!

8. Price Discrimination • Charging different prices for the same product or service. • Necessity of distinctive markets with different price elasticities • Necessity of being able to prevent movement between the markets • Examples: train travel – peak time and off peak, electricity charges – off peak metering, telephone calls

9. RPI minus/plus formulas (Redistribution Pricing) • Price regime imposed on privatised utilities to help protect the public from monopoly exploitation of essential services (Remember RPI now replaced by the CPI) • 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% • 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%

10. Contestable Markets

11. Contestable Markets • Theory developed by William J. Baumol, John Panzar and Robert Willig (1982) • Helped to fill important gaps in market structure theory • Perfectly contestable market – the pure form – not common in reality but a benchmark to explain firms’ behaviours

12. Contestable Markets • Key characteristics: • Firms’ behaviour influenced by the threat of new entrants to the industry • No barriers to entry or exit • No sunk costs • Firms may deliberately limit profits madeto discourage new entrants – entry limit pricing • Firms may attempt to erect artificial barriers to entry – e.g…

13. Contestable Markets • Over capacity – provides the opportunity to flood the market and drive down price in the event of a threat of entry • Aggressive marketing and branding strategies to ‘tighten’ up the market • Potential for predatory or destroyer pricing • Find ways of reducing costs and increasing efficiency to gain competitive advantage

14. Contestable Markets • ‘Hit and Run’ tactics – enter the industry, take the profit and get out quickly (possible because of the freedom of entry and exit) • Cream-skimming – identifying parts of the market that are high in value added and exploiting those markets

15. Contestable Markets • Examples of markets exhibiting contestability characteristics: • Financial services • Airlines – especially flights on domestic routes • Computer industry – ISPs, software, web development • Energy supplies • The postal service?