Pricing Strategy and Entry Barrier Types

Contents: Here we look at…..

  • What barriers to entry there can be?
  • Pricing strategies firms use
  • Consumer and Producer Surplus

Barriers to entry

You know we have said that barriers to entry are a major factor in defining what market we are in. Well what barriers can there be? We have only hinted at it, without disclosing any real examples.

Innocent barriers to entry

Caused by firms when they are minding their own business, literally.

  1. Economies of Scale are such a barrier in concentrated markets, for which small businesses cannot reduce costs enough to compete, any other firm than a giant is stopped.
  2. Strong Brand: A brand is a symbol of trusted quality placed on a product, often taking years to build up.
  3. Indivisibilities of large capital are along the same lines, again stopping small time entrants which cannot afford that giant mine or digger or 747.
  4. Network effects, are barriers prevalent in social media and communications. If you have a product which is only of use if others are using it e.g Vodafone, Facebook, Live Messenger, then starting out is difficult.

Strategic Barriers to Entry

When firms are interfering with another’s prospective business, to mind their own.

  1. Patents, intellectual property rights, copyright: A magic formula, a slogan, an innovation: These are protected by the courts and cannot be replicated by an entrant.
  2. Advertising & development: Firms deliberately incur costs in trying to better entrants and competitors. The burden is to develop ones brand, through advertising and product development.
  3. Outlet location. If you can get you’re shop to London Victoria Rail Station and JFK Airport in New York than you are in for big money. This is the advantage Duncan Bannatyne  used, in his early days of manning Ice Cream vans, to raise enough money to found a care home.

Pricing Strategies.

Well, we have also hinted at this before, maybe mentioning one or two. Why does a firm charge what price it does? Why does this often change? This often depends on what market structure a firm is in, current scenario and firm mentality. Here are some strategies………

Cost Plus pricing is the most common and simple. Why does an ice cream charge £1.50 for a Magnum? Well, it charges a certain price to assure a profit on sale. This is all this strategy is!

To Get The Audience…..

Penetration Pricing. Ever had a new takeaway open up charging ridiculously low prices? Remember Lidl coming to the UK? An entrant to a market may price very low, even below cost to get people to try their product and build up loyalty, so they will stay when the price rises.

Loss Leader. Ryanair comes to mind. Here the firm charges their main product at a loss(very cheap) to get demand, than makes profits on needed add ons and extras to make the product work(like going to the toilet, or getting bags). The cheap main product induces consumers.

To Keep The Audience…..

Limit Pricing. Once a firm has a share of the market, it wants to keep it. When it hears of a potential competitor, it may lower it’s price to deter the competitor from setting up.

Predatory Pricing. Tesco got accused of this in the mid 1990’s. A very large firm may be tired of the smaller rivals taking it’s share and price so low for a time to drive out it’s rivals. Predatory pricing is where the price is below cost, and the giant can cross subsidise or rely on investments, whilst lossmaking, and outlast the others.

To Follow The Others……

‘Dominant Price Leadership’ or following the best. A firm may simply look at what prices the biggest in the business charges, and follow it’s exact movements. Just like an investor following Warren Buffett.

Barometric Price Leadership. I still have that thing which predicts the weather in my house. Well, we may have a firm which can predict demand conditions like this and price accordingly. The rest of the market may know of an intelligent firm and copy their price movements.

Collusion! As said in Oligopoly. Others rise their prices, the firm rises theirs upon agreement to make their lives easier. Simply following one another’s price change in the typical price ring. Remember this is against competition law and can see huge fines dished out.

To Make The Best Of Demand Conditions………

Off peak Pricing. During commute train prices are high, prices are low in between. When we have fairly fixed capacity and variable demand for a product, such price movements are common. Firms prices simply adjust to the market, high prices with demand and vice versa. Such pricing can be seen as allocatively efficient with little excess demand/supply.

Price Discrimination

This is a large part of the syllabus in AQA and is useful for the exam(there may even be a question solely about it and examples, conditions etc!).

Different groups paying different prices for the same product.

What it needs: A firm can only do this when it is in an imperfect market, has some inelasticity of demand for it’s product. It may seek to take advantage of the fact that some consumers are willing to pay a higher max price than others.

How it’s Done.. A market must be segmented, into groups of consumers with different price elasticities of demand. Inelastic demand groups are charged higher prices(wage earning adults), elastic demand groups often discounted(students, tourists which have more choice control).

Those groups must have a differential or character, which it is possible to tell. Age groups and previous discounted customers is an example. Firms can then pull off market segmenting.

Finally there needs to be a way of stopping those charged lower to selling on to the group charged higher. Buying on the door or security checks/details etc can stop this.

Consumer and Producer Surplus

When we look at how overall welfare is affected by changes in markets, we tend to look at how it changes consumer and producer surplus, the satisfaction level. Generally measured as the sum of surplus per good.

Consumer Surplus is the difference between the maximum a consumer is willing to pay for a good and the good’s price. If it is high, consumers are paying much less than their max, many ‘bargains’.

Producer Surplus is the difference between the minimum a firm is willing to supply a good for and the money they actually get for it. Price minus marginal cost. Firms stop supplying in a competitive market when P=MC, proucer surplus max.

When we have an equilibrium in a competitive market, the producer and consumer surplus is as above.

Deadweight Welfare Loss

When our market is not perfectly competitive, however, firms do not produce up to where price=marginal cost, because the prodit maximising level is at a lower output as demand has inelasticity.

Taking the above market, we have output before the supply and demand curves intersect, surplus is lost! The consumer and producer surplus foregone is the deadweight welfare loss. This is the typical argument against a monopolised market.

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One Response to Pricing Strategy and Entry Barrier Types

  1. Pingback: Thinktank « Zahablog's Economic Page

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