Administrative Issues

Response to Feedback

More cases Cases coming up

GE vs. Westinghouse Bitter Competition African Communications Group Raytheon

Lead time for ordering HBS cases such that we can’t add HBS cases at this point.

Will try to add some “mini-cases.” Also some philosophy here about value of deductive vs.

inductive learning for business. Will post questions about HBS & other cases (as did with

GE vs. Westinghouse).

Feedback continued … More student participation

Okay, but two-way street – you have to talk up, ask questions, point out connections, etc.

Give more explanation and guidance about CSG Will talk about in a moment

Give some guidance about the final exam Final will consist of

Short problems to test understanding of theoretical ideas (1/3 roughly)

Short answer questions about aspects of strategic situations (1/3 roughly)

A case analysis (1/3 roughly) I have posted some examples of the type of questions I’ve asked

previously on the course web site (“Exam questions from old exam …”).

Some Things that are Tricky

Be more clear when assignments are due … but best laid plans:

Confusion over when case reader would be ready Technical problem with CSG Stochastic elements in pacing of course

Switch to Catalyst Never used it Will look into it this weekend … but no promises.

One Thing I Won’t Do Distribute printed handouts & lecture notes

Not clear there’s sufficient demand and not clear demand for what.

Expensive (even at 6 slides/page, double sided, talking 720 pages per lecture on average).

Logistically a pain: Dear Haas Community,

Unfortunately, BOTH Xerox digital copier / printers (rooms F-580 & S-545) are presently DOWN. Please do not send print jobs to either machine until further notice. Service is pending. I apologize for the inconvenience.

Yours truly,Kurt, the Copy Guy

Fails the market test

CSG

Grading Dependent on how you do given your situation. Based on your strategy memorandum

It’s intended to be experiential learning I “want” mistakes to happen because through their

analysis we learn Remember Carter Racing – you don’t learn a lot

looking at just your successes Clarification

You produce to order

Avoiding the Bertrand Trap II: Cooperation

How do Coke & Pepsi Make Money? Coke and Pepsi sell essentially

undifferentiated products Prices are widely known, often advertised There are no consumer switching costs No evidence of serious limits on capacity No evidence of cost advantages

Coke and Pepsi Recognize Repeated Interaction Suppose Coke forbears cutting price today

because it knows Pepsi will follow suit tomorrow.

Suppose Pepsi forbears cutting price today because it knows Coke will follow suit tomorrow.

Tradeoff for Coke or Pepsi is forgoing a larger market share today in order to avoid the Bertrand trap tomorrow.

Method 6: Exploit Repeated Play If firms play repeatedly, then can use

repeated play to sustain a form of cooperation on price known as tacit collusion

No firm cheats (undercuts rivals) because this will trigger a price war in the future (e.g., reversion to Bertrand competition).

To Cheat or Not to Cheat:That is the Question

PDV of profits PDV of profits

time time1

Cheat(undercut)

Cooperate(tacitly collude)

Looking Looking justjust at today: at today:

Profits from just undercutting rivals

and capturing entire market.

Profits from matching rivals at

monopoly price but sharing market.



time time1

Cheat(undercut)


Now take into account Now take into account the the future!future!



time time1

Cheat(undercut)


Benefit today But Bertrand

trap forever after.

Smaller benefits today (because split market). But positive benefits in future.

To Cheat or Not to Cheat:More Firms


time time1

Cheat(undercut)


To Cheat or Not to Cheat:Higher Interest Rate


time time1

Cheat(undercut)


Tacit Collusion

Tacit collusion is easier to sustain when fewer firms (four or fewer if excess capacity) interest rate low

To Cheat or Not to Cheat:Dying Industry

Expected PDV of profits Expected PDV of profits

time time1

Cheat(undercut)


Dying Industries

In fact, if “death date” known with certainty, then cooperation generally not sustainable at all.

Backwards induction: In last period there is no future period, so no

punishment to deter cheating in last period. Hence cheating (Bertrand) in last period

But then same is true of penultimate period and so on back to first period.

General Phenomenon

Firm going bankrupt not paid by other firms that owe it money.

Management problems when boss announces she’s leaving.

Basically don’t let others know the end is coming.

The Issue with Detection


time time1

Cheat(undercut)


2

Detectionoccurs

The Issue with Detection:Stochastic Discovery (Demand Fluctuation)


time time1

Cheat(undercut)


Detectionoccurs

Possibly lost tomistaken price

war

When Demand Fluctuates

Play trigger strategies Sometimes to avoid temptation, firms don’t charge

maximum price during high-demand periods Evidence that gasoline refiners don’t charge maximum

price during summer, the high-demand season. If too much (unpredictable) variability in demand,

then would have price wars too often. Hence, value of tacitly colluding is reduced. Relative cost of cheating today is reduced. So difficult or impossible to sustain tacit collusion.

Making Tacit Collusion Work

Incentive to cut price?

Tacit collusion not an issue

no

yes

Easy to detect price

cuts? Tacit collusion will fail & the firms risk finding them-selves in the Bertrand trap

no

no

no

Firms willing to punish?

Can serious punishments be

inflicted?

yes

yes

yes

Tacit collusion is sustainable in equilibrium

Electronic Components Distribution Industry How do we assess the potential for tacit

collusion in the electronic components distribution industry?

Making Tacit Collusion WorkElectronic Components Distribution Industry



no

yes



no

no

no



inflicted?

yes

yes

yes


Making Tacit Collusion WorkAirline Industry



no

yes



no

no

no



inflicted?

yes

yes

yes


VSVS..

Exiting a Price War

Need to signal that price war at end without engaging in illegal explicit collusion. American Airlines and the NYT Price leaders

Traditional leaders are GM in automobiles American Airlines in airline industry Tesco is a price leader with respect to Asda and Sainsbury

Public adoption of means for facilitating tacit collusion

Facilitating Tacit Collusion:Improving Detection Firms want to make sure that

cheating is detected promptly cheating is detected accurately

Numerous devices to make this work public posting of prices simplified pricing

e.g., GE and Westinghouse airlines & per-mile pricing

collection & dissemination of prices (some antitrust issues—Maple Flooring Mfrs.’ Ass’n v. United States)

Making Punishments Severe


time time1

Cheat(undercut)


Making Punishments Severe


time time1

Cheat(undercut)


Increase the severity Increase the severity of the punishmentof the punishment

How to Make Severe

Most Favored Nation Clauses MFN: If cut price today, give refund to past

customers. Note: the other guy better adopt this too!

Also contemporaneous MFN: All customers get same price today (makes detection of price cutting easier)

How to Make Willing

Build in “doomsday devices” Dr. Strangelove

Meeting the Competition Clauses (MCC) state that will meet lowest price available

just advertised policy or put into contracts (some antitrust issues)

if rival cuts price, either honor clause (a reputational or contractual obligation) or suffer consequences.

We miss you Stanley

Tacit Collusion on Non-Price Dimensions to Lessen Price Competition When tacit collusion on price would be

difficult, firms can tacitly collude to maintain conditions that lessen price competition

Generally, these are conditions that make one of the assumptions of the Bertrand model fail.

Concept of market discipline.

Tacit Collusion on Non-Price Competition Raising search costs

tacit agreements not to price advertise not locating outlets near each other

Raising switching costs making products incompatible with rivals’ signing customers to long-term contracts Note: As we will see, these can also serve to

deter entry.

Tacit Collusion on Non-price Competition Restrict capacity

Firms can tacitly agree not to expand capacity Note: can be difficult to coordinate

Think about GE vs. Westinghouse Industrial capacitor industry In reverse: lead additive industry

Product Differentiation

Tacitly agree to split market on non-price dimensions location: non-overlapping territories (usually

invites antitrust scrutiny) product space: e.g., split market between high-

end and low-end

Other Dimensions of Tacit Collusion

R&D (Non-price) advertising No poaching

Take-aways GE vs. Westinghouse Price fixing is illegal – you can go to jail for it. Tacit collusion requires

An ability to detect deviation Sufficient punishments

Sometimes need to facilitate tacit collusion By improving ability to detect (e.g., multiplier,

audits) By increasing punishments, including use

“doomsday devices” (e.g., MFN) By serving as a price leader

Conclusions

Recognizing repeated play can allow firms to avoid the Bertrand trap via tacit collusion. Tacit collusion is distinct from explicit collusion or

pricing fixing, which is illegal. Tacit collusion works best when

The number of firms is relatively small. The future is sufficiently important. Detection of undercutting is easy and not too

subject to error.

Conclusions (continued …)

Firms can take steps to facilitate tacit collusion Making prices public Using MFN and MCC clauses to increase

punishment Signal to each other through the press and other

means But be careful: Devices intended to facilitate

tacit collusion can run afoul of the antitrust authorities.

Conclusions (continued …)

The logic of repeated games has many applications in business. Among them … Payments to bankrupt firms Treatment of a leaving supervisor Quality assurance (see reading) Entry deterrence (upcoming)

List of some of the firms and industries mentioned American Airlines Asda Coca-Cola GE Pepsi Sainsbury Tesco Westinghouse

Airline industry Electronic components

distribution industry Industrial capacitor

industry Lead additive industry Maple flooring industry

Administrative Issues

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