Administrative Issues

Response to Feedback

More cases

Cases coming up

GE vs. Westinghouse
Bitter Competition
African Communications Group
Raytheon

Lead time for ordering HBS cases such that we cant add
HBS cases at this point.
Will try to add some mini-cases.
Also some philosophy here about value of deductive vs.
inductive learning for business.
Will post questions about HBS & other cases (as did with GE
vs. Westinghouse).

Feedback continued

More student participation

Give more explanation and guidance about CSG

Okay, but two-way street you have to talk up, ask questions,
point out connections, etc.
Will talk about in a moment

Give some guidance about the final exam

Final will consist of

Short problems to test understanding of theoretical ideas (1/3 roughly)

Short answer questions about aspects of strategic situations (1/3
roughly)
A case analysis (1/3 roughly)

I have posted some examples of the type of questions Ive asked

previously on the course web site (Exam questions from old
exam ).

Some Things that are Tricky

Be more clear when assignments are due

but best laid plans:

Confusion over when case reader would be ready

Technical problem with CSG
Stochastic elements in pacing of course

Switch to Catalyst

Never used it
Will look into it this weekend but no promises.

One Thing I Wont Do

Distribute printed handouts & lecture notes

Not clear theres sufficient demand and not clear demand for what.
Expensive (even at 6 slides/page, double sided, talking 720 pages
per lecture on average).
Logistically a pain:

Dear Haas Community,

Unfortunately,
BOTH Xerox digital copier / printers (rooms F-580 &
S-545) are presently DOWN. Please do not send print
jobs to either machine until further notice.
Service is pending. I apologize for the
inconvenience.
Yours truly,
Kurt, the Copy Guy

Fails the market test

CSG

Grading

Its intended to be experiential learning

Dependent on how you do given your situation.

Based on your strategy memorandum
I want mistakes to happen because through their
analysis we learn
Remember Carter Racing you dont learn a lot
looking at just your successes

Clarification

You produce to order

Avoiding the Bertrand

Trap II: Cooperation

How do Coke & Pepsi Make

Money?

Coke and Pepsi sell essentially

undifferentiated products
Prices are widely known, often advertised
There are no consumer switching costs
No evidence of serious limits on capacity
No evidence of cost advantages

Coke and Pepsi Recognize

Repeated Interaction

Suppose Coke forbears cutting price today

because it knows Pepsi will follow suit
tomorrow.
Suppose Pepsi forbears cutting price today
because it knows Coke will follow suit
tomorrow.
Tradeoff for Coke or Pepsi is forgoing a larger
market share today in order to avoid the
Bertrand trap tomorrow.

Method 6: Exploit Repeated

Play

If firms play repeatedly, then can use

repeated play to sustain a form of
cooperation on price known as tacit
collusion
No firm cheats (undercuts rivals) because
this will trigger a price war in the future (e.g.,
reversion to Bertrand competition).

To Cheat or Not to Cheat:

That is the Question
Looking just at today:
Cheat
Cooperate
(undercut)
PDV of profits

(tacitly collude)
PDV of profits

Profits from just

undercutting rivals
and capturing entire
market.

time

Profits from
matching rivals at
monopoly price but
sharing market.

time

To Cheat or Not to Cheat:

That is the Question
Now take into account
the future!
Cheat
PDV of profits

(undercut)

Cooperate
PDV of profits

time

(tacitly collude)

time

To Cheat or Not to Cheat:

That is the Question
Cheat
PDV of profits

Benefit
today

(undercut)

Cooperate
PDV of profits

Smaller benefits
today (because
split market). But
positive benefits in
future.

But Bertrand
trap forever
after.

(tacitly collude)

time

time

To Cheat or Not to Cheat:

More Firms
Cheat

Cooperate

(undercut)
PDV of profits

(tacitly collude)

PDV of profits

time

time

To Cheat or Not to Cheat:

Higher Interest Rate
Cheat

Cooperate

(undercut)
PDV of profits

(tacitly collude)

PDV of profits

time

time

Tacit Collusion

Tacit collusion is easier to sustain when

fewer firms (four or fewer if excess capacity)

interest rate low

To Cheat or Not to Cheat:

Dying Industry
Cheat
(undercut)
Expected PDV of profits

Cooperate
(tacitly collude)
Expected PDV of profits

time

time

Dying Industries

In fact, if death date known with certainty,

then cooperation generally not sustainable
at all.
Backwards induction:

In last period there is no future period, so no

punishment to deter cheating in last period.
Hence cheating (Bertrand) in last period
But then same is true of penultimate period and
so on back to first period.

General Phenomenon

Firm going bankrupt not paid by other firms

that owe it money.
Management problems when boss
announces shes leaving.
Basically dont let others know the end is
coming.

The Issue with Detection

Cheat

Cooperate

(undercut)
PDV of profits

(tacitly collude)
PDV of profits

Detection
occurs

1 2

time

time

The Issue with Detection:

Stochastic Discovery (Demand
Fluctuation)
Cheat

Cooperate

(undercut)
PDV of profits

(tacitly collude)
PDV of profits

Detection
occurs

Possibly lost to
mistaken price
war

time

time

When Demand Fluctuates

Play trigger strategies

Sometimes to avoid temptation, firms dont charge
maximum price during high-demand periods

Evidence that gasoline refiners dont charge maximum

price during summer, the high-demand season.

If too much (unpredictable) variability in demand,

then would have price wars too often.

Hence, value of tacitly colluding is reduced.

Relative cost of cheating today is reduced.
So difficult or impossible to sustain tacit collusion.

Making Tacit Collusion Work

no

Incentive to
cut price?

Tacit collusion
not an issue

yes
Easy to
detect price
cuts?

yes

no
no

Can serious
punishments be
inflicted?

yes
Tacit
collusion is
sustainable
in equilibrium

Firms
willing to
punish?

yes

no

Tacit
collusion will
fail & the
firms risk
finding themselves in the
Bertrand trap

Electronic Components
Distribution Industry

How do we assess the potential for tacit

collusion in the electronic components
distribution industry?

Making Tacit Collusion Work

Electronic Components Distribution
Industry
no

Incentive to
cut price?

Tacit collusion
not an issue

yes
Easy to
detect price
cuts?

yes

no
no

Can serious
punishments be
inflicted?

yes
Tacit
collusion is
sustainable
in equilibrium

Firms
willing to
punish?

yes

no

Tacit
collusion will
fail & the
firms risk
finding themselves in the
Bertrand trap

Making Tacit Collusion Work

Airline Industry
no

Incentive to
cut price?

Tacit collusion
not an issue

yes
Easy to
detect price
cuts?

yes

no
no

Can serious
punishments be
inflicted?

yes
Tacit
collusion is
sustainable
in equilibrium

Firms
willing to
punish?

yes

no

Tacit
collusion will
fail & the
firms risk
finding themselves in the
Bertrand trap

VS.

Exiting a Price War

Need to signal that price war at end without

engaging in illegal explicit collusion.

American Airlines and the NYT

Price leaders

Traditional leaders are

GM in automobiles
American Airlines in airline industry
Tesco is a price leader with respect to Asda and Sainsbury

Public adoption of means for facilitating tacit

collusion

Facilitating Tacit Collusion:

Improving Detection

Firms want to make sure that

cheating is detected promptly

cheating is detected accurately

Numerous devices to make this work

public posting of prices

simplified pricing

e.g., GE and Westinghouse

airlines & per-mile pricing

collection & dissemination of prices (some antitrust issues

Maple Flooring Mfrs. Assn v. United States)

Making Punishments Severe

Cheat

Cooperate

(undercut)
PDV of profits

(tacitly collude)

PDV of profits

time

time

Making Punishments Severe

Cheat

Cooperate

(undercut)
PDV of profits

(tacitly collude)
PDV of profits

Increase the severity

of the punishment

time

time

How to Make Severe

Most Favored Nation Clauses

MFN: If cut price today, give refund to past

customers.

Note: the other guy better adopt this too!

Also contemporaneous MFN: All customers get

same price today (makes detection of price
cutting easier)

How to Make Willing

Build in doomsday devices

Dr. Strangelove

Meeting the Competition Clauses (MCC)

state that will meet lowest price available

just advertised policy

or put into contracts (some antitrust issues)

if rival cuts price, either honor clause (a

reputational or contractual obligation) or suffer
consequences.
We miss you Stanley

Tacit Collusion on Non-Price

Dimensions to Lessen Price
Competition

When tacit collusion on price would be

difficult, firms can tacitly collude to maintain
conditions that lessen price competition
Generally, these are conditions that make
one of the assumptions of the Bertrand model
fail.
Concept of market discipline.

Tacit Collusion on Non-Price

Competition

Raising search costs

tacit agreements not to price advertise

not locating outlets near each other

Raising switching costs

making products incompatible with rivals

signing customers to long-term contracts
Note: As we will see, these can also serve to
deter entry.

Tacit Collusion on Non-price

Competition

Restrict capacity

Firms can tacitly agree not to expand capacity

Note: can be difficult to coordinate

Think about GE vs. Westinghouse

Industrial capacitor industry
In reverse: lead additive industry

Product Differentiation

Tacitly agree to split market on non-price

dimensions

location: non-overlapping territories (usually

invites antitrust scrutiny)
product space: e.g., split market between highend and low-end

Other Dimensions of Tacit Collusion

R&D
(Non-price) advertising
No poaching

Take-aways GE vs.
Westinghouse

Price fixing is illegal you can go to jail for it.

Tacit collusion requires

An ability to detect deviation

Sufficient punishments

Sometimes need to facilitate tacit collusion

By improving ability to detect (e.g., multiplier,

audits)
By increasing punishments, including use
doomsday devices (e.g., MFN)
By serving as a price leader

Conclusions

Recognizing repeated play can allow firms to

avoid the Bertrand trap via tacit collusion.

Tacit collusion is distinct from explicit collusion or

pricing fixing, which is illegal.

Tacit collusion works best when

The number of firms is relatively small.

The future is sufficiently important.
Detection of undercutting is easy and not too
subject to error.

Conclusions (continued )

Firms can take steps to facilitate tacit

collusion

Making prices public

Using MFN and MCC clauses to increase
punishment
Signal to each other through the press and other
means
But be careful: Devices intended to facilitate
tacit collusion can run afoul of the antitrust
authorities.

Conclusions (continued )

The logic of repeated games has many

applications in business. Among them

Payments to bankrupt firms

Treatment of a leaving supervisor
Quality assurance (see reading)
Entry deterrence (upcoming)

List of some of the firms and

industries mentioned

American Airlines
Asda
Coca-Cola
GE
Pepsi
Sainsbury
Tesco
Westinghouse

Airline industry
Electronic components
distribution industry
Industrial capacitor
industry
Lead additive industry
Maple flooring industry