CHAPTER 7
When Other Firms Don’t Respond
CHAPTER SUMMARY AND TEACHING OBJECTIVES
A primary objective management should be to earn economic profits over the long-term. The greatest
threat for not meeting this objective is the entry of competitors into the market place. Entry causes
economic profits to dissipate. This chapter addresses strategies that deter entry under an assumption that
other firms do not respond to your actions. It is necessary to see that fundamental strategic decisions
like branding, for example, are ways to deter entry. This is the economists approach to developing
strategy.
IMPORTANT TERMS
Production Possibilities Curve (PPC) a curve showing combinations of outputs that can be
produced/created when existing resources and technology are fully and efficiently used
Best practice frontier is a curve showing the best that can be done with existing resources and
technology
Competitive advantage for a firm, this is what you do relatively better than others.
Five forces model developed by Michael Porter and presents five components that must be considered
for strategy to be effective
Resource-based model looks at the fit between the external market context in which a company
operates and its internal capabilities
Core competency things that a company can do relatively better than others
Chapter 7: When Other Firms Don’t Respond 29
TOPICS AND TEACHING SUGGESTIONS
1. Choices
Managers are faced with many choices. Business strategy is essentially a choice. There are several
models that can assist the choice process is many ways. These include the five forces model, the
resource-base model, and the VRIN/VRIO framework. An interesting question is ‘is management
economics or is economics management? Usually strategy is taught within management
departments of schools of business. Is this the proper location for this area?
2. Restricting Entry
ANSWERS TO EXERCISES
1. Does a firm make use of comparative advantage in allocating its resources? What factors give
a firm a comparative advantage?
2. Under what conditions are the two strategies of low cost and high quality a tradeoff? Under
what conditions would the efficient frontier not be an appropriate picture of the two
strategies?
3. What is the best practices frontier? How does this relate to competitive advantage?
4. Why is growth a primary strategy of almost every firm? Would it ever make sense to “stand
5. Jack Welch is heralded as a great leader of General Electric (GE). His strategy to acquire
companies in different lines of business based on the requirement that each business in GE
was to become the #1 or #2 competitor in the industry is touted as being particularly brilliant.
While very successful, could there have been a fundamental flaw in Welch’s strategy?
What was the overall goal of GE? While the individual units of GE had goals, what was the
overall goal of GE? To simply be the best is not necessarily a competitive advantage. Other
1) grow larger – AHERF
3) Diversify – Walmart, PepsiCo
5) Outsource production – Nike, IKEA
7) Become cost leader – Kia, Motel 6
9) Drive Rivals from market – Philip Morris, Microsoft
11) Imitate – Acer Computer, Xerox
Explain where on the best practice frontier each would lie.
8. How is national strategy different from firm strategy? How are the two the same?
9. Use what you know about Starbucks and apply the VRIO/VRIN approach to evaluate
Starbucks, as you know it. Use the five forces model to evaluate Starbucks. Is the five forces
model different from the VRIO model? Explain
VRIO/VRIN
Valuable: Starbucks tries to be unique
Rare: The Starbucks experience tries to be unique
10. Suppose that two firms, A and B compete. They can choose different strategies – a
combination of low price or high quality. The tables below show the best practice frontiers for
each firm.
Chapter 7: When Other Firms Don’t Respond 31
A’s Possibilities
Price
Quality
0
12
1
8
2
4
3
0
B’s Possibilities
What is the cost to A of 1 unit of high quality? What is the cost to B of 1 unit of high quality?
What is the cost to A of 1 unit of price? What is the cost to B of 1 unit of price? Which firm
should focus on high quality? Which on low price? Explain.
11. Texas Instruments once announced a price for random-access memories that wouldn’t be
available until two years after the announcement. A few days later, Bowmar announced that it
would produce this product and sell it at a lower price than Texas Instruments. A few weeks
later, Motorola said it, too, would produce this product and sell it below the Bowmar price. A
few weeks after this, Texas Instruments announced a price that was one–half of Motorola’s.
The other two firms announced that, after reconsidering their decision, they would not
produce the product. What do you think Texas Instruments’ reason for announcing the price
of a product two years before it was actually for sale was?
12. Explain how a strategy of increasing expenditures on advertising could deter market entry.
Advertising creates public awareness. New competitors must make the public aware of them as
Price
Quality
0
6
2
4
4
2
6
0
13. Coke and Pepsi have sustained their market dominance for nearly a century. General Motors
and Ford have lost their dominance. What is the difference between the two cases.
14. Currently, a fast food firm has a monopoly in the university student union. The monopoly
pays the university $75,000 a year to maintain the monopoly. The firm earns an economic
profit of $290,000 per year. Another fast food firm is desirous of entering the market and
offering its fare to students. The manager of the first firm calls the university president
asking her to maintain the first firm’s monopoly. How much would the first firm be willing
to pay to keep the monopoly?
15. A first mover is dominating a market, with revenues of $40 million annually. The average
total cost for the firm is $20 million, of which $19 million is fixed. How can the first mover
keep others from entering the market?
16. When would limit pricing make sense? What price should serve as the limit?
17. The following data represent a firm serving a specific transportation market.
a. What price maximizes revenue? $1,300
b. What price maximizes profit? $1,350
c. What is fixed cost? $1,000
d. This firm faces a rival that cuts its revenue significantly. The firm has decided to undertake
predatory pricing to drive the other firm out of business. The other firm has a cost structure
that looks like the following:
Total Cost $2,000 $3,000 $4,000 $5,000 $6,000 $7,000 $8,000
Total Output 0 1 2 3 4 5 6
0
$
0
$1,000
1
$1,700
$2,000
2
$3,300
$2,800
3
$4,800
$3,500
4
$6,200
$4,000
5
$7,500
$4,500
6
$8,700
$5,200
7
$9,800
$6,000
8
$10,800
$7,000
$11,700
$9,000
Total Output
Total Revenue
Total Cost
9
Chapter 7: When Other Firms Don’t Respond 33
What price would drive the firm out of business? How much would it cost the incumbent firm to
drive the rival out of the market? Could the firm raise the price to recoup the losses?
18. Explain the differences between perfect competition, monopoly, monopolistic competition,
and oligopoly.
19. Why would a firm want to deter entry? How much would a monopolist spend to keep other
firms out of its market?
20. Explain why predatory pricing hardly works in the real world.