Pricing Strategies and Contestable Markets

http://www.bized.ac.uk

Copyright 2006 – Biz/ed

Pricing Strategies and Contestable Markets



Pricing



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



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



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?



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!

OPEC Meeting in Vienna – OPEC influences the supply of oil to fix prices

Copyright: Getty Images available from Education Image Gallery



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

Busy times on the trains means a lower price elasticity of demand and a higher price to maximise revenue

Title: Tokyo trains. Copyright: Getty Images available from Education Image Gallery



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%



Contestable Markets



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



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 made

to discourage new entrants – entry limit pricing

– Firms may attempt to erect artificial barriers to entry – e.g…



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



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



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?

Pricing Strategies and Contestable Markets

Documents

Transcript of Pricing Strategies and Contestable Markets