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Pricing Strategies and

Contestable Markets

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Pricing Strategies and

Contestable Markets

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Pricing

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Pricing
• Pricing – How a business
approaches its pricing strategies
depends on the market structure
it operates in
• Pricing can be a means of
competing – not only to take
customers of rivals but to prevent
competition from rivals

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Price Takers
• Price takers – have little or no control
over the price they charge
• Perfect Competition – P = MR = AR = MC =
AC
 Firms have to take the price set by the market
 Large number of sellers – each has small market
share and therefore no control over the market
 Examples may include agricultural products, some
types of financial product – stocks and shares
• Price Leadership – Dominant firm sets price,
rest have to take this price

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Price Leadership
• Price leadership occurs where a dominant firm
in an industry in which products are good substitutes
is able to set price which others in the industry,
on account of their smaller size, will follow
• Examples include: Some commodity markets where
there is a dominant seller, the computer software
industry (Microsoft), petroleum, some forms
of pharmaceutical products
• May tend to exist in ‘micro-markets’ rather than the
whole company market – e.g., no real price leadership
in cereal market except for Weetabix?

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Price Fixing
• Price Fixing – where firm/s fix
prices at levels above
equilibrium on account of their
market power or through
selling/distribution
arrangements generally termed
collusion. e.g. sports replica
kits, children’s toys and games,
steel, motor vehicles
• Cartels – Organised price fixing
– e.g. OPEC (Organisation of
Petroleum Exporting Countries)
• Price fixing is illegal – type in
OPEC Meeting in Vienna – OPEC influences the supply
of oil to fix prices ‘price fixing’ into a search engine to get
details of companies and organisations
Copyright: Getty Images available from Education Image Gallery around the world accused of, and
convicted of, price fixing!

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Price Discrimination
• Charging different prices
for the same product or
service.
• Necessity of distinctive
markets with different
price elasticities
• Necessity of being able
to prevent movement
between the markets
• Examples: train travel –
peak time and off peak,
Busy times on the trains means a lower price electricity charges –
elasticity of demand and a higher price to maximise
revenue off peak metering,
Title: Tokyo trains. Copyright: Getty Images available from telephone calls
Education Image Gallery

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RPI minus/plus formulas

(Redistribution Pricing)
• Price regime imposed on privatised utilities to help
protect the public from monopoly exploitation
of essential services (Remember RPI now replaced
by the CPI)
• RPI minus – price changes in line with the annual rate
of inflation minus a set percentage, e.g. RPI – 4% - if
RPI was 3% implies the firm would have to look at
cutting prices to consumers by 1%
• RPI plus – imposes maximum price increases, e.g. RPI
+2%, if RPI was 2% firm only able to increase prices
to customers by max 4%

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Contestable Markets

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Contestable Markets
• Theory developed by William J. Baumol,
John Panzar and Robert Willig (1982)
• Helped to fill important gaps in market
structure theory
• Perfectly contestable market – the
pure form – not common in reality but a
benchmark to explain firms’ behaviours

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Contestable Markets
• Key characteristics:
– Firms’ behaviour influenced by the threat
of new entrants to the industry
– No barriers to entry or exit
– No sunk costs
– Firms may deliberately limit profits made
to discourage new entrants – entry limit
pricing
– Firms may attempt to erect artificial barriers
to entry – e.g…

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Contestable Markets
• Over capacity – provides
the opportunity to flood the market
and drive down price in the event
of a threat of entry
• Aggressive marketing and branding
strategies to ‘tighten’ up the market
• Potential for predatory or destroyer
pricing
• Find ways of reducing costs and
increasing efficiency to gain competitive
advantage
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Contestable Markets
• ‘Hit and Run’ tactics – enter the
industry, take the profit and get
out quickly (possible because of
the freedom of entry and exit)
• Cream-skimming – identifying
parts of the market that are high
in value added and exploiting
those markets

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Contestable Markets
• Examples of markets exhibiting
contestability characteristics:
– Financial services
– Airlines – especially flights
on domestic routes
– Computer industry – ISPs, software,
web development
– Energy supplies
– The postal service?

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