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Industrial Economics: Threat of Price War - Essay Example

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Industrial Economics: Threat of Price War Introduction “When a company wants to increase its market share, usually the easiest way is to reduce prices, which increases product sales”(Price war, 2011). The above strategy will force competitors also to reduce the prices of their products…
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Industrial Economics: Threat of Price War
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Download file to see previous pages In a heavily globalized and competitive business world, price wars often occur between different firms to gain control in the market. For example, James Quinn (2012) has pointed out that “Ocado is to cut its prices on a range of products in a bid to steal a march on rivals such as Tesco in the battle for online supermarket delivery customers” (Quinn, 2012). Price wars affect the market in many ways. “There's nothing wrong with offering two different products at two different prices for two different markets, as long as the products really are different”(Brodsky, 2012). However, price wars often occur in the same market and that also with respect to similar products. Price wars can discourage potential competitors from entering a market. This paper analyses how a threat of price war can discourage entry by potential competitors and the actions that might help an organization to make price war threat credible. How a threat of price war can discourage entry by potential competitors? “A price war breaks out when entrants arrive. During the price war, the entrants' price is below the incumbent's price. It is even below the entrants' costs”(Elzinga & Mills, 1999, p.4). Entry into a new market is extremely difficult for an organization especially when the market was highly competitive. It should be noted that even though the number of market players are increasing as a result of globalization and liberalization, the number of potential consumers remains almost the same. In other words, it is difficult for new entrants to create new customer base. They have to canvass the customers of their competitors. However, existing customers may not switch over to a new entrant unless they were convinced either by the quality or by the prices of the competing products. Compared to the entrant, an incumbent may have some advantages also. Long run average cost (LRAC) of the entrant could be more than that of the incumbent which is evident from the following graph. (Industrial economics – Lecture 9: Barriers to entry and entry deterring strategies, slide 4) Incumbent will be able to reduce LRAC because of; Access to superior technology, Hold patents, Trade secrets, Exclusive ownership/control over factor inputs and Cheaper sources of finance etc. Thus it is easy for the incumbent to reduce the prices. (Industrial economics – Lecture 9: Barriers to entry and entry deterring strategies, slide 5) Economies of scale is another factor which causes problems to the entrant. Economies of scale refers to the cost advantages that an organization obtains due to expansion. It should be noted that it is easy for the incumbent to control the expansion cost because of its better awareness in the market. On the other hand an entrant may be forced to pay more cost for expansion because of its lack of knowledge about the market. From the above graph is evident that the new entrant will have to pay a higher absolute cost (AC) penalty if it wishes to enter this market which can make the entry unprofitable. Limit pricing is another strategy used by incumbents to block the entry of entrants. Limit pricing is nothing but charging prices below the monopoly prices which is described in the graph below. It should be noted that the incumbent was charging monopoly prices earlier. The threat from new entrants forced them to adjust the prices based on the market demand. It is difficult for the entrant to reduce the p ...Download file to see next pages Read More
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