Administrative Issues

Response to FeedbackMore casesCases coming upGE vs. WestinghouseBitter CompetitionAfrican Communications GroupRaytheonLead time for ordering HBS cases such that we cant 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 participationOkay, but two-way street you have to talk up, ask questions, point out connections, etc.Give more explanation and guidance about CSGWill talk about in a momentGive some guidance about the final examFinal will consist ofShort 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 Ive asked previously on the course web site (Exam questions from old exam ).

Some Things that are TrickyBe more clear when assignments are due but best laid plans:Confusion over when case reader would be readyTechnical problem with CSGStochastic elements in pacing of courseSwitch to CatalystNever used itWill look into it this weekend but no promises.

One Thing I Wont DoDistribute printed handouts & lecture notesNot clear theres 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 GuyFails the market test

CSGGradingDependent on how you do given your situation.Based on your strategy memorandumIts intended to be experiential learningI want mistakes to happen because through their analysis we learnRemember Carter Racing you dont learn a lot looking at just your successesClarificationYou produce to order

Avoiding the Bertrand Trap II: Cooperation

How do Coke & Pepsi Make Money?Coke and Pepsi sell essentially undifferentiated productsPrices are widely known, often advertisedThere are no consumer switching costsNo evidence of serious limits on capacityNo evidence of cost advantages

Coke and Pepsi Recognize Repeated InteractionSuppose 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 PlayIf firms play repeatedly, then can use repeated play to sustain a form of cooperation on price known as tacit collusionNo 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 QuestionPDV of profitsPDV of profitstimetime1Cheat(undercut)Cooperate(tacitly collude)Looking just at today:

To Cheat or Not to Cheat:That is the QuestionPDV of profitsPDV of profitstimetime1Cheat(undercut)Cooperate(tacitly collude)Now take into account the future!

To Cheat or Not to Cheat:That is the QuestionPDV of profitsPDV of profitstimetime1Cheat(undercut)Cooperate(tacitly collude)Benefit todayBut Bertrand trap forever after.Smaller benefits today (because split market). But positive benefits in future.

To Cheat or Not to Cheat:More FirmsPDV of profitsPDV of profitstimetime1Cheat(undercut)Cooperate(tacitly collude)

To Cheat or Not to Cheat:Higher Interest RatePDV of profitsPDV of profitstimetime1Cheat(undercut)Cooperate(tacitly collude)

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

To Cheat or Not to Cheat:Dying IndustryExpected PDV of profitsExpected PDV of profitstimetime1Cheat(undercut)Cooperate(tacitly collude)

Dying IndustriesIn 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 periodBut then same is true of penultimate period and so on back to first period.

General PhenomenonFirm going bankrupt not paid by other firms that owe it money.Management problems when boss announces shes leaving.Basically dont let others know the end is coming.

The Issue with DetectionPDV of profitsPDV of profitstimetime1Cheat(undercut)Cooperate(tacitly collude)2Detectionoccurs

The Issue with Detection:Stochastic Discovery (Demand Fluctuation)PDV of profitsPDV of profitstimetime1Cheat(undercut)Cooperate(tacitly collude)DetectionoccursPossibly lost tomistaken price war

When Demand FluctuatesPlay trigger strategiesSometimes to avoid temptation, firms dont charge maximum price during high-demand periodsEvidence that gasoline refiners dont 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 WorkIncentive to cut price?Tacit collusion not an issuenoyesEasy to detect price cuts?Tacit collusion will fail & the firms risk finding them-selves in the Bertrand trapnononoFirms willing to punish?Can serious punishments be inflicted?yesyesyesTacit collusion is sustainable in equilibrium

Electronic Components Distribution IndustryHow do we assess the potential for tacit collusion in the electronic components distribution industry?

Making Tacit Collusion WorkElectronic Components Distribution IndustryIncentive to cut price?Tacit collusion not an issuenoyesEasy to detect price cuts?Tacit collusion will fail & the firms risk finding them-selves in the Bertrand trapnononoFirms willing to punish?Can serious punishments be inflicted?yesyesyesTacit collusion is sustainable in equilibrium

Making Tacit Collusion WorkAirline IndustryIncentive to cut price?Tacit collusion not an issuenoyesEasy to detect price cuts?Tacit collusion will fail & the firms risk finding them-selves in the Bertrand trapnononoFirms willing to punish?Can serious punishments be inflicted?yesyesyesTacit collusion is sustainable in equilibrium

VS.

Exiting a Price WarNeed to signal that price war at end without engaging in illegal explicit collusion.American Airlines and the NYTPrice leadersTraditional leaders areGM in automobilesAmerican Airlines in airline industryTesco is a price leader with respect to Asda and SainsburyPublic adoption of means for facilitating tacit collusion

Facilitating Tacit Collusion:Improving DetectionFirms want to make sure thatcheating is detected promptlycheating is detected accuratelyNumerous devices to make this workpublic posting of pricessimplified pricing e.g., GE and Westinghouseairlines & per-mile pricingcollection & dissemination of prices (some antitrust issuesMaple Flooring Mfrs. Assn v. United States)

Making Punishments SeverePDV of profitsPDV of profitstimetime1Cheat(undercut)Cooperate(tacitly collude)

Making Punishments SeverePDV of profitsPDV of profitstimetime1Cheat(undercut)Cooperate(tacitly collude)Increase the severity of the punishment

How to Make SevereMost Favored Nation ClausesMFN: 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 WillingBuild in doomsday devicesDr. StrangeloveMeeting the Competition Clauses (MCC)state that will meet lowest price availablejust advertised policyor 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 CompetitionWhen tacit collusion on price would be difficult, firms can tacitly collude to maintain conditions that lessen price competitionGenerally, these are conditions that make one of the assumptions of the Bertrand model fail.Concept of market discipline.

Tacit Collusion on Non-Price CompetitionRaising search coststacit agreements not to price advertisenot locating outlets near each otherRaising switching costsmaking products incompatible with rivalssigning customers to long-term contractsNote: As we will see, these can also serve to deter entry.

Tacit Collusion on Non-price CompetitionRestrict capacityFirms can tacitly agree not to expand capacityNote: can be difficult to coordinateThink about GE vs. WestinghouseIndustrial capacitor industryIn reverse: lead additive industry

Product DifferentiationTacitly agree to split market on non-price dimensionslocation: non-overlapping territories (usually invites antitrust scrutiny)product space: e.g., split market between high-end and low-end

Other Dimensions of Tacit CollusionR&D(Non-price) advertisingNo poaching

Take-aways GE vs. WestinghousePrice fixing is illegal you can go to jail for it.Tacit collusion requiresAn ability to detect deviationSufficient punishmentsSometimes need to facilitate tacit collusionBy improving ability to detect (e.g., multiplier, audits)By increasing punishments, including use doomsday devices (e.g., MFN)By serving as a price leader

ConclusionsRecognizing 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 whenThe 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 collusionMaking prices publicUsing MFN and MCC clauses to increase punishmentSignal to each other through the press and other meansBut 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 firmsTreatment of a leaving supervisorQuality assurance (see reading)Entry deterrence (upcoming)

List of some of the firms and industries mentionedAmerican AirlinesAsdaCoca-ColaGEPepsiSainsburyTescoWestinghouseAirline industryElectronic components distribution industryIndustrial capacitor industryLead additive industryMaple flooring industry