4:
Global Topic Market Power and
Anti-Trust Issues
REQUIRED READINGS: Forever DeBeers and U.S.
Antitrust Law
Online DeBeers Case Discussion: 3/13/4
****Discussion ends on a SUNDAY****
In-class DeBeers Case Debriefing: 3/5
Firms with Market Power
Market power exists when firms are able to
restrict competition to sustain prices above
marginal cost.
Monopoly has 100% market power.
Market power can exist with multiple rival firms if
products are differentiated and/or markets are
segmented (i.e. firms have loyal customers).
To gain market power, the managers job is to
attempt to sustain any factors which limit
competition.
Strategies to Restrict Competition
Market Strategies:
Guarding trade secretes.
Control of an essential resource.
Exclusive contracts and customer lock-in.
Coke on campus.
Extended cell phone contracts.
Collusion (form a cartel and act as a monopoly).
Non-Market Strategies:
Patent or copyright protection.
Trade regulations.
Government Licensing
Government or NGO certification.
Profit Maximization
The profit maximizing sales target occurs where
marginal revenue equals marginal cost.
If MR>MC then the firm could make a profit by selling
one more unit.
If MC>MR then the firm would lose money on selling
the unit.
Given the optimal sales target, price is found as
a markup over cost, where the markup factor
depends on the demand for the product.
More inelastic demand results in a higher mark up
over costs.
Market Power Pricing Graphically
$
Pf CS
PS
INE
Pe
MC
D (consumer value)
Qf
Qe
Q
MR
A firm with market power sets price higher and
output lower than efficient levels.
From the viewpoint of economic efficiency too few
units are produced and sold, giving up some that
have value greater than costs.
Perfect Price Discrimination
Perfect Price Discrimination: Each consumer is
charged a price equal to her willingness to pay.
No inefficiency occurs, but all market surplus goes to
the producer (CS = 0).
Profits are increased relative to using a single price.
$
P1
P2
PS
MC
PN
D
Qf=Qe
Q
Imperfect Price Discrimination
Imperfect Price Discrimination: Groups of
consumers are charged different prices.
Profits are increased relative to using a single price,
but not as high as using perfect price discrimination.
Consumer surplus is decreased, but consumer
surplus is not equal to zero.
$
CS
P1
P2
INE
P3
PS
MC
D
(1)
(2)
(3)
Q
Basics of Game Theory
Players:
These are the decision makers within the game.
Usually within firms, government, or interest groups.
Strategies:
These are the decision choices.
Price, Products, Advertising, Campaigning, lobbying,
Regulation, etc
Payoffs:
These are the outcomes of the decision choices.
Usually in terms of profits or losses.
Basics of Game Theory
Dominant Strategy:
A strategy that results in the highest payoff for a player
regardless of what strategy their rival plays.
Secure Strategy:
In absence of a dominant strategy, play the strategy that
guarantees the highest payoff given the worst payoff.
Think like your Rivals:
In absence of a dominant strategy, look at the game from your
rivals perspective.
Nash Equilibrium:
A condition describing a set of strategies in which no player
can improve her payoff by unilaterally changing her strategy,
given her rivals strategy.
Strategic Pricing Decisions
Normal Form Game:
A representation of a game
that reveals the players,
their possible strategies,
and the resulting payoffs.
Simultaneous-move, oneshot, games.
Adidas
Low Price
Nike
Low Price
High Price
High Price
(4,7)
(5,10)
(7,8)
(6,12)
Strategic Pricing Decisions
Dominant Strategy: Nike (none exists),
Adidas(high)
Secure Strategy: Nike (high), Adidas (high)
Thinking Like your Rival: Nike should see that
Adidas will always play (high) and play (low)
Nash Equilibrium: (low, high)
Adidas
Low Price
Nike
Low Price
High Price
High Price
(4,7)
(5,10)
(7,8)
(6,12)
Monitoring and Mixed Strategies
Environmental
Protection
Agency
Polluting Firm
Comply
(-1,1)
Monitor
(1,-1)
Dont Monitor
Dominant Strategy: None exist.
Cheat
(1,-1)
(-1,1)
Nash Equilibrium: None exist.
Both want to keep their actions secrete.
It is best for the players to play a mixed (or
randomized) strategy.
Randomize over a strategy set to not allow rivals to
predict your action.
Airline Collusion Dilemma
Both have dominant a strategy to play
So Nash equilibrium is
This is a dilemma as payoffs would be
But collusion to all go to
Government regulation can be used to force collusion to
the tighter standards and increase industry profits
across all firms.
Rival Airlines
AMR
Current Policy
Tighter Standards
Current
Policy
(0,0)
(-5,5)
Tighter
Standards
(5,-5)
(2,2)
Multistage Sequential Move Game
Extensive-form Game:
A representation of a
game that summarizes
the players, the available
information, the
available strategies, the
resulting payoffs, and
the sequence of moves.
Pepsi
Out
Coke
50, 100
Soft
Enter
Hard
225, 275
200, 300
Multistage Sequential Move Game
Coke
Pepsi
Out
50, 100
Soft
Enter
Hard
225, 275
200, 300
Nash Equilibriums:
Subgame perfect equilibrium:
A set of strategies that allows no player to improve his own
payoff at any stage of the game by changing strategies.
Work backwards from your rivals strategy.
The Role of Government
Promote Competition:
The U.S. has enacted antitrust policies that make it
illegal to attempt to monopolize a market.
Sherman Act (1890):
Makes monopolizing a market, cartels, and other
collusive arrangements illegal.
Clayton Act (1914):
Makes price discrimination illegal, and also targets M&A
activity that significantly lessons competition.
The Department of Justice looks at M&A activity
based on its potential effect on industry competition.
The Role of Government
Promote Competition:
The Department of Justice uses industry sales
concentrations as an indication of the level of
competition.
The 4-Firm Concentration Ratio (C4):
The fraction of industry sales that goes to the four largest
firms in the industry.
A C4 closer to one signals an un-competitive industry.
The Herfindahl-Hirshman Index (HHI):
The sum of squared market shares of firms in an industry
multiplied by 10,000.
An HHI above 1,800 signals an un-competitive industry.
The DeBeers Case
Is DeBeers a monopoly or a cartel? Make sure to describe the
DeBeers business model. Have the members of the DeBeers
organization been stable over the years or has there been any
defections or diamonds leaking to the market?
-
It is a cartel acting as a monopoly. It is a collection of mines and a
collection of sellers.
-
Members have not been stable.
-
Collusion = chances to cheat
-
Defections- Israel and Zaire leaked diamonds into the market in the
past; Russia and Angola defected.
The DeBeers Case
What is the role of the Central Selling Organization (CSO)? How
does DeBeers and the CSO use the process of Stockpiling? Think
about what market forces (S&D) DeBeers can control with
stockpiling? Can they control both Demand and Supply (shift S&D)?
-
Within DeBeers, the price and quantity are perfectly controlled.
-
CSO is the central hub; mines to CSO to retailers.
-
They can directly shift both supply and demand
Do US antitrust laws apply to non-US firms? Has the US been
successful at prosecuting DeBeers? Make sure to explain why they
have or have not been able to prosecute DeBeers.
-
Yes they apply to non-US firms if they get to the US market.
The DeBeers Case
Nicky Oppenheimer openly talks about the DeBeers business model
as violating US antitrust laws, but he thinks the company should be
left unchallenged. What arguments did Nicky Oppenheimer give to
support why DeBeers should not be prosecuted by the US? Are they
compelling?
-
Diamonds are beneficial for African economies.
-
Talks to Harvard students (future politicians)
-
Talks after the US passed the African Development and Growth Act
The DeBeers Case
Ailing from added competition and added pressures from US
investors, DeBeers called upon Bain Consulting to conduct a
strategic review of its business model. What were the findings of this
strategic review? Did DeBeers approach to advertising or brand
names change, and if so, how?
-
Bain said to exploit the brand.
-
Grow your market share not the market. Steal from competitors
-
Antitrust problems now because you can see where the diamond
comes from.
-
Needs to get access to the US market. Cut out middlemen.
Case Update: 2006 DeBeers settled a class action antitrust lawsuit in
the US ($295 million in damages), and has gained the right to open
stores in the US.
2010, the settlement is being appealedwait and see whats next.