Economics & Worlds

Front Row Seats in the Market Competition.

noreply@blogger.com (Häly Laasme) — Mon, 05 Apr 2010 19:46:00 +0000

             If you live in Cumberland County, New Jersey, Upper Deerfield Township area, it is possible that you have noticed a novel local resident – materialization of the Theory of Industrial Organization. With the recent tenant, Aldi, the preconditions for the price war have been realized and the battle is on!
             First arrived Acme, then came ShopRite, some years ago opened Wal-Mart and now entered Aldi to already overcrowded local market. Upper Deerfield Township is a rural area with about 8000 inhabitants and a volatile migratory population, because it is an agricultural area. Yes, there are settlements around the township, like Bridgeton, which has three times as many people, but there are also grocery stores in those areas and their populations should not be the influential factor for rationalizing the opening of the new store in area that already has 2 grocery chains and Wal-Mart. The latter is a small store with capacity to provide only the basic groceries, but in this situation its price strategy is still highly relevant because the distance between the stores is so miniscule that most of the time the loss of gas or time does not overweight the savings in price. To emphasize the distance between the stores, one can say that all four could have opened their businesses in the same shopping mall and split the sunk cost of building it.
             The strategic interactions between these firms have become quite fascinating and for the local folks it offers a free lesson in economics and game theory without exorbitant tuition fee.One definite observation is that the original dominant firm, Acme, passed on its torch to ShopRite already several years ago and it is quite pondering to rationalize the continuation of Acme in the present operational form. Its customer flow seems to be almost nonexistent and thus the profits must be questionable. Considering an assumption that the rational for-profit firm typically pursues profit-maximization, what is the strategy of this store; to outride its sad situation in the hope of the better future? Maybe the store is expecting a significant increase in the local population, maybe its books are evening out despite the sluggish sales or perhaps its loss is compensated by some other store’s profits. It is difficult to infer what the management of Acme or that particular store has forecasted but in any case one cannot but be amazed over its determination to exist while pursuing non-competitive pricing strategy. Its actions make anybody wonder about the length of its contracts that require such sticky prices? It is also possible, but highly unlikely, that the store is performing under altruistic motives and is worried about putting its employees under the guillotine, since the positive growth in the local labor market has been almost inexistent. Therefore, as much as one finds fascinating the battle between the stores over the local customers, it is simultaneously captivating to observe Acme opening its doors day after day and the puzzling question remains – how do they do it or what is the underlining motive.
             Going back to the competition over the clientele with assumption that Acme is not a viable threat, it looks more and more that ShopRite is the strongest incumbent firm that would be capable of eliminating some of the existing rivals or deterring anybody else from entering the market; although, Aldi obviously did not find ShopRite promotions credible enough to be dissuaded from the area. Maybe Aldi rationalized that if Acme could coexist with ShopRite almost a decade there must be enough customers to serve its business, especially if Acme would decide to exit the market in the future. As a result, everybody in Upper Deerfield Township gets to enjoy capitalism in its most competitive form; even though, some of us are searching for the pinnacle of the price war while others are relishing the customer heaven.
             When we are talking about competitive strategies, there are always two sides to the story. The customers welcome any kind of release in expenses and often give little thought to the duration of the phenomenon, if it is temporary or long term, especially during the economic downturn; while enterprises, in majority, seek for profits and prefer the long-term prosperity over the short term struggles. Less competition means higher profits and the longer it is attainable the better. That is why we have antitrust laws, like Sherman Act, that are created to abolish the attempts of market monopolization and cartels; hence also any predatory conduct that is designed for achieving that objective. To suggest predatory conduct or anticompetitive strategy, there must be a case that the firm which is conducting it will profit from those actions after the rivals have exited the market and it will incur the cost during the execution of the anticompetitive strategy. In the case of Upper Deerfield, any firm that wins will make profit, because it is a rural settlement and generally the grocery stores do not grow here like mushrooms after the rain; therefore, the winner will take all the customers and has a privilege to price most of its products like a monopoly. And the prices that locals have been seeing during the last couple weeks have become quite concerning, especially when 3 to 5 dollar items suddenly get priced as dollar items, which also means that the stores are very likely incurring the costs from their strategies. If the township would be a small European country, there would be manufacturers and farmers already picketing outside the supermarkets (and dumping their milk or burning their hay, like European farmers have been doing lately) against unfair price practices and relegation of their livelihood; but, fortunately, Upper Deerfield Township is not another country and thus its inhabitants can probably enjoy this economic phenomenon much longer than anybody in Europe could. In addition, there is a fine line between predatory conduct and cost-efficiency and one can certainly argue the latter, in some cases, for Aldi. At first, as a new competitor, it really had no other choice for the entrance than aggressive pricing; anything else would have been a suicide. It has to establish its position among the customers who already have three stores to choose from. Secondly, it unambiguously demonstrates the cost-saving innovations: quarter-carts, no “free” shopping bags, non-current assets that have slower depreciation and would not require high maintenance costs, and products with unfamiliar brand names. Considering all the possible cost efficiencies; some of its prices are still questionable and surely would not be attainable in the long run.
             At the same time ShopRite is a store with lot of substitutes and complements to choose from in any product category. One would go to that store just for variety if not for anything else. Meanwhile, that store perpetually struggles with its inventory, what is also intriguing, bearing in mind that every department has its own manager and if not trained, could be trained to balance its inventories accordingly. The most challenging part of its operations seems to be procurement of the promotional items. This is one of its weaknesses that can become quite frustrating to the customer and therefore, gives a chance to a new entrant to manipulate the customers’ preferences to its advantage. With the same note, the price level of the agricultural products in ShopRite should not be as high as it has been and often has artificial aftertaste, as this is a rural area and one can find a stand with fruits and vegetables at every corner. Therefore, the prices of the seasonal items should be much lower than they usually are, but are probably kept higher for the farmers’ delight.
             While discussing this price war, one has to mention one more alternative strategy option that the local consumers should consider. This is, of course, purely hypothetical and not an attempt to insinuate that any such illegal actions are actually taking place. What if a store “A” (and out of the respect to the businesses there are no names in this hypothesis) realizes after a decade long battle that it cannot induce the store “B” to leave the market and win the sole position for profits. Therefore, it decides to collude with another store “C” in persuading the store “B” to close; in return, the store “A” will promise not to enter some specific market where store “C” is already dominant. Even though, there seems to be a price war between stores “A” and “C”, in reality it is all a well orchestrated theater for snatching the store “B’s” loyal customers. Once this has happened and store “B’s” losses force it to exit the market, store “C” will pack up and leave too. After all, the store “C” did not make any significant capital investments to start with and thus its losses from exiting the market will not reflect profoundly on its balance sheet. Quite contrary, it will gain more from cooperation with the store “A,” this way they both can price like monopolies on their local markets.
             In conclusion, a warning of caution to everybody who is enjoying their front row seats to this market competition, an age-old proverb tells us that nothing on this planet is for free and hence, sooner or later somebody will have to pay for the bill. But while it lasts, there are several ways to optimize this opportunity. One can stock up for the future or spread the grocery list over several stores and act like incoherent citizen who cannot figure out his or her preferences. Hopefully this will keep the stores fighting longer and extend the reaping period for benefits. Since Acme has demonstrated its resilience against the tough price strategies of ShopRite almost a decade, it would be a shame to see it close as a result of the emerged price war between Aldi and ShopRite. What if, afterwards, Aldi realizes that it had underestimated the competitiveness of ShopRite and decides to leave the market too? Then the only true losers will be the consumers in Upper Deerfield Township, whose only hope will be Wal-Mart’s partial pressure on ShopRite to keep some of its prices half decent.

Häly Laasme

“Price-Matching” – Are You a Free Spy for the Competitors?

noreply@blogger.com (Häly Laasme) — Mon, 05 Apr 2010 16:53:00 +0000

             The competition for customers is becoming more intense and prevalent - if nothing else would persuade people to shop until they drop then at least the “price-matching” clause should prevail against the competitors. Thus, buyer, be aware of unpaid labor you are providing to corporations on this tough labor market. The ecstatic consumers will be actively haggling with Customer Service without realizing how they are actually working as free market-spies for the companies, or even worse - are helping to maintain the cartel discipline, that otherwise would cost thousands of research dollars.
             In the contemporary world many companies have highly diversified product portfolios to preserve the risk averseness; consequently, it complicates the competitiveness capability on the market, especially the assurance of profit-maximizing prices. Nobody is interested of pricing at marginal cost; the objective is to earn as much profit as possible for the effort of manufacturing and vending the merchandise to the consumers. Subsequently the question raises how to monitor the prices on the market to guarantee that your company is not left in the dry or how to convince your competitors to price favorably to your business, way above your variable and fixed costs?
             When there are several superstores in the same vicinity with extensively heterogeneous product mix within the store, it can become tremendously expensive and strenuous to keep track of all of their prices. Assuming that most of the ordinary customers are seeking the bargain, the business that is capable of pricing lowest, while still making operating profit, will clearly have the competitive edge, at least in one element of the market mix. Therefore, to survey the surrounding competitors, managements offer price-matching promise to the customers, who would then implicitly monitor the market and report the price differences of all of their opponents in attempt to get a fair deal. One would not think about this as anti-competitive strategy but there is an externality to the actions of consumers; albeit, this anti-competitive strategy is legal because the marketing clause is offered to the customers and not to the competitors. Unfortunately, the buyers are the ones that will lose in this market equilibrium.
             For example, Target advertises about cutting the prices and Wal-Mart will reply with the price-matching clause at which Target will correspond analogously. Preceding actions were not pro-competitive but contrary and actually reinforce the trigger strategies that maintain collusive behavior between these two superstores, even if it was unintentional. These clauses will guarantee that both of these stores will not attempt to undercut each other’s prices, because the option where one store prices high and the other low is beneficial to neither, Wal-Mart nor Target. The latter is unattainable equilibrium in the payoff matrix with the sequential strategies, where firms have frequent interactions, because the firm with higher prices will lose significantly in revenues and thus in profits. Both of them will not price low either because then they will have to price near marginal cost to assure that the opponent can’t price lower, which is not the best profit-maximizing strategy; thus, Wal-Mart and Target will both price high, like implicit cartel, knowing that if one lowers the prices then the other will too and thus in the sequence of strategies they will decrease their prices near marginal cost and will only hurt their revenues. The price-matching strategy here works like deterrent between the businesses that sell homogeneous products and neither store will have incentive to deviate from the high price. For that reason, shoppers will end up with higher prices than they would have otherwise, without the price-matching clause. This could be partly a reason why Target announced the cutting of its prices so early in the season, to give adequate time for the competitors to respond to its strategy and hence it would not have to cut the prices during the holiday shopping as much as it would have had to otherwise to lure the consumers to their stores; plus, one has to agree that the advertisement of price-cutting alone will entice anyone at least to window-shop and ultimately purchase something before they leave the store.
             While talking about the price-matching and-cutting during the holiday season, it is very important to keep in mind the time-window that is extremely specific for that purpose. The businesses have to guarantee that their price strategies will produce profit and the quantity sold will compensate the decrease in prices. From the point of stores the demand is highly elastic during the Christmas season because small percentage change in price can make a huge change in quantity demanded as consumers will just pick another store for gifts. As the dawn of Christmas day approaches and most of the people have concluded their shopping, the demand actually becomes an inelastic procrastinator demand market, where the stores can raise the prices without decreasing their sales that much because those last minute shoppers don’t have time to look for bargains and most likely don’t care about them either. At certain point, for some stores, the market could become almost perfectly inelastic and the businesses could post whatever price they want, ceteris paribus, without negatively affecting quantity demanded. For example, one could imagine an increasing concave function within particular time interval where elasticity is a slope of the function and at minimum, where slope is infinite, the market is highly elastic, in the beginning of Christmas shopping season, and at its maximum point, on Christmas Day, the elasticity equals zero because quantity demanded will be unresponsive to the change in price – the procrastinators will need their gifts regardless of the prices and the people who are done with their gift wrapping are already waiting the After Christmas Sale. Unfortunately to the businesses, hiking prices in almost empty stores will not make much difference at this point. Therefore, timing is incredibly relevant in conducting price-strategies and here the price-matching will help to abate the problem of the asymmetry of information between the businesses and allow the stores to utilize this particular time frame for holiday shopping more efficiently and profitably.
             In addition, the price-matching policy is actually a common element in Wal-Mart sales strategy, although its policy is quite ambiguous and often up to every store manager’s discretion. This prevailing strategy maintains its competitive edge on the local market and warns its opponents against cutting prices below its own; hence, one of the reasons why small stores with poor diversity in products are not capable of competing against Wal-Mart and have to exit the market after its entrance. When Wal-Mart offers a price-matching policy to the customers, its size and variety of articles alone guarantees the win on the provincial market because it can spread the loss of revenue from some items over the wide product mix, by increasing the prices of other items. While it price-matches the goods of the prey it can increase the prices on the other items, but since it has such a huge variety of goods it only has to rise the prices of other products slightly and thus from the customer’s point of view “penny here or there” will not make much difference in convenience of getting all your shopping done at one place. If a small store would try to do the same, it would have to hike the prices of other products considerably and thus will lose too many customers to avoid bankruptcy. Hence, it is very difficult for small mom-and-pop stores to offer price-matching policy and compete with huge stores, like Wal-Mart.
             Therefore, next time when you feel temptation of bringing your receipt to the Customer Service in the name of price-matching, think twice before you act to make sure that you are not the free spy for the competitor or the promoter of collusive behavior. As customers, we all love the competitive markets because their ability to offer us lower prices; thus, we have to do our own part in promoting the long term benefits over the instant gratification of a cheaper product.

Häly Laasme