Abstract
This case presents a classic duopoly situation. Two shipping firms are in the midst of a price war over the market of containerized shipping to and from a small Caribbean Island. The case presents a table of contributions to both firms, which depend on their respective prices. The tables of contribution serve as a major basis by the concepts of price leadership; prisoner’s dilemma and Nash equilibrium are explored. The main issues addressed in the case include competitive dynamics, international case, game theory, pricing, pricing leadership, and diversity case. The setting of the case is the transportation sector. Predatory pricing would not be a good pricing decision in San Huberto due to demand inelasticity of the market. If KL could initiate price leadership strategy, it would be very hard for LAL to set unique prices. Vaughan noted that if LAL and KL set identical prices, KL would most likely retain a larger market share
Decision Problem
The main decision that the case presents concerns the issues surrounding the pricing strategy in a duopoly market. Ideally, the decisions concerning equilibrium pricing, predatory pricing, price leadership, prisoner’s dilemma and the role played by market share in pricing are considered in detail.
Decision Alternatives and Evaluation
Predatory Pricing
Predatory pricing occurs through sharp discounting, which in reduces the profits margins just as the same in a price war, which results in profits to fall. The main test of predatory pricing is to consider whether the difference in cost between the manufacturing costs and the price being charged to the consumers is exercise. However, businesses may engage in predatory pricing as a long-term pricing strategy (Salzano & Kirman, 2005). Predatory pricing may not be fair game, especially to competitors who are not financially strong or stable. Such weak competitors may even suffer greater extents of reduced profits and great loss of revenues. The pricing strategy utilized by Lesser Antilles Lines (LAL) was intended at "running them out of the market," which sought to run its major competitor, Kronos Lines (KL) (Bodily et al., 1998). It was a poor strategy given the price inelasticity of demand in the market. Pricing competition would hurt the firm’s performance at the expense of market share. Additionally, it was unusual practice in San Huberto market for the importers to divide their orders between the major shipping lines. Lowering the prices would, therefore, make it even more risky since this would make it difficult to run the competitors out of the market.
Price Leadership
Price leadership occurs when a firm that leads its sector determines the price of services or goods. Price leadership strategy leaves the rivals of the leaders with very little choice but only to follow its lead and match these prices if they have to hold on to their market share (Wang et al., 2015). However, competitors may choose to lower their prices hoping to gain the market share as the discounters. KL was the market leader in San Huberto as it was the only firm before the introduction of LAL (Bodily et al., 1998). If KL could initiate price leadership strategy, it would be very hard for LAL to set unique prices.
Prisoner’s Dilemma
Prisoner’s dilemma is a very standard example of a critical game in game theory (Parkin, 2010). It shows why two completely rational firms might not in any way corporate, even if it tends to appear that it is in their best interest to do so. For instance, this can be used to explain why LAL and KL would not corporate in price setting even if it would appear to be the best thing to do. In some instances, cooperating concerning price setting may be beneficial to both parties. However, in some other situations, the two competitors may find it expensive or even difficult to coordinate in price setting.
Price Considerations in a Duopoly
A duopoly is a situation where only two major firms serve the market. When setting a pricing strategy, one firm must consider the decisions of other (Wang et al., 2015). The decision taken by a competitor will affect the pricing decision taken by the other firm. For instance, in the case of LAL and KL, the pricing decision taken by KL would most likely affect the decision of LAL as both firms serve the market. If LAL opts to reduce its prices significantly, KL would be required to reduce their price if they have to maintain their market share. The pricing decision would even affect Lesser Antilles Lines (LAL) more negatively due to KL had gained more loyalty and a bigger market share. Vaughan noted that if LAL and KL set identical prices, KL would most likely retain a larger market share (Bodily et al., 1998). If KL reduced its prices considerably, then LAL would be required to follow suit if the market share had to be maintained. The pricing strategy would affect the profits of LAL negatively as it would have to reduce its revenues; if at all KL reduced its prices.
Role of Market Share in Pricing
Market share plays a very big role in pricing decision taken by firms in an oligopoly market. For instance, since KL had a bigger market share compared to LAL, the only option left for LAL was to set its process lower than those of its competitors to maintain or increase the market share (Bodily et al., 1998). The decision might, in turn, affect the profits of LAL significantly.
Equilibrium Pricing
In equilibrium pricing, the market price is determined by the forces of demand and supply (Wang et al., 2015). It is the fairest pricing decision for the market players as the prices set in the market are not subjective. Additionally, this strategy may not affect the profits of the firms negatively.
Conclusion
An oligopoly market is one is made up of two major competitors. In such a market setting, the decision taken by one firm is likely to affect the pricing decision taken by the other firm. Predatory pricing would not be a good pricing decision in San Huberto due to demand inelasticity of the market. Price leadership strategy leaves the rivals of the leaders with very little choice but only to follow its lead and match these particular prices if they have to hold on to their market share. Prisoner’s dilemma is a very standard example of a very critical game in game theory.
References
Bodily, S. E., Carraway, R.L., Frey, Jr., S.C. & Pfeifer, P.E. (1998). Quantitative business analysis: Text and cases. Boston: Irwin/McGraw-Hill.
Wang, X. S., Xie, Y., Jagpal, H. S., & Yeniyurt, S. (2015). Coordinating R&D, Product Positioning, and Pricing Strategy: A Duopoly Model. Customer Needs and Solutions, 1-11.
Parkin, M. (2010). Economics. Boston: Addison-Wesley.
Salzano, M., & Kirman, A. (2005). Economics. Milan: Springer-Verlag.
Fazeli, A., & Jadbabaie, A. (2012, December). Duopoly pricing game in networks with local coordination effects. In Decision and Control (CDC), 2012 IEEE 51st Annual Conference on (pp. 2684-2689). IEEE.
