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IRISH CASE STUDY: Why Irish Supermarkets Say 'No' to a
Price War This case examines an Irish example of an oligopoly and applies game theory to consider the interdependent behaviour of the firms in the retail grocery industry. It refers to concepts introduced in chapter 10 Until recently two major supermarkets - Tesco and Dunnes Stores - dominated the Irish grocery market. In the past they have used various promotions to gain advantage over one another such as advertising campaigns, in-store promotions, free gifts and loyalty cards which give points for each purchase. Occasionally there have been outbreaks of price competition on a limited range of products for a specific time period, but in general the industry has been accused of maintaining high prices to the disadvantage of the public. In November 1999 a new competitor entered the market. Aldi, a German discount supermarket chain opened its first two stores in Dublin and Cork, and within a few months opened a further two in Letterkenny and Galway. Aldi's no-frills, low-price approach immediately captured price-conscious shoppers. Consumers were attracted by discounts of up to 30 per cent on a range of 500 own-brand goods. For example, in December, milk at the Aldi store in Cork only cost 89p for two litres, 25p less than at other local supermarkets. With Aldi's current plans to open between four and six more supermarkets before the end of 2000, what should Dunnes Stores and Tesco do? Should they let Aldi enter the market without any response or should they try to keep Aldi out? Should they engage in a price war? The key to understanding the dilemma facing the supermarkets is accessible through a game theoretic approach. Game theory provides a tool for thinking about how contracts are shaped. Real life strategic situations are complicated and filled with uncertainty. Game theory provides a way to simplify a problem and highlight the key points needed to make the best choices. Good decisions require that each decision-maker anticipates the decisions of others. To do this each company must 'put themselves in the other companies shoes' and then make their decisions based on how they think the other will act. In this way each company can try to predict well in advance the actions, responses and counter responses of all their rivals and then choose the best route or the best strategy for themselves. Games are classified according to the number of player involved, the compatibility of their interests and the number of replays of the game. In this game their are three players, Tesco, Dunnes Stores and Aldi. Tesco and Dunnes Stores are called incumbents as they are already well-established in the market place. In this game both incumbents have very similar interests, both wish to sell as much as possible while maintaining high prices. If they lower prices they will loose profits. Aldi is known as the entrant, it is new to the Irish market. To survive Aldi must attract consumers to its stores and away from the incumbents. This game is an example of a non co-operative game. This type of game does not allow collusive communications or side payment schemes between players. Therefore, while the incumbents have similar interests they must make their decisions independently. In fact, the Irish Competition Authority forbids the formation of a cartel or any other type of collusive behaviour which may inhibit competition. The game is a repeated game as players repeatedly make the same decision in the same environment. Each day each of the supermarkets must decide whether to charge a higher or a lower price for each of its goods. It is also a sequential game, meaning that one player moves first and the others follow. When Aldi entered the market in November it committed itself to lower prices - this was its stated strategy. Signals were used to make the commitment credible. An example of a signal is an advertising campaign. To work as a signal, it must not only cost Aldi something to undertake it, but also the other supermarkets must know that it would cost Aldi more if they misrepresent information about their strategy than if they were truthful. In any case, if a supermarket in Ireland advertises one price but charges another they can be fined heavily by the Office of Consumer Affairs. Game theory can be used to understand the players actions and reactions over time. The easiest way to identify the problem facing the supermarket chain is to draw a payoff table (or matrix) as follows:
The dilemma facing the companies is identical to the Prisoners Dilemma. The best strategy is for all three to set a high price (Why is this so?). However, in the absence of enforcement mechanisms there is an incentive for one supermarket to cheat by agreeing to charge a high price, then charging a lower price than rivals and selling more. For example, suppose on 1st July 2000 all three supermarkets charge 85p for a loaf of bread. On 5th July, Aldi decides to cut the price to 40p and it advertises this the day before. After Aldi's announcement many customers wishing to buy bread will go to their store as it will save them 45p. What will the other supermarkets do? Looking at the table above, we see that their best response to Aldi's low price to also charge a low price. By 8th July everybody is charging a low price, sharing the customers as they did on 1st July but all getting smaller profits. What should they do to overcome the dilemma? In a repeated game players can use various competitive strategies and avoid price wars. For example, players can differentiate their product. This can be done by establishing extreme brand loyalty to the incumbent. In this case, even in the face of differentially higher prices, customers reject the new entrants. This is a trend Tesco have been building since they entered the market in 1997. Or players could try to innovate which involves recognising the ongoing nature of price rivalry and attempting to mitigate the intensity of the price competition by growing the market. e.g. Tesco have introduced low-interest credit-cards. Another strategy would be customer segmentation where prices would be matched to a very targeted customer segment and limited capacity would be released for sale to that market segment. e.g. 'Two for the price of one' and 'while stocks last' promotions. Since Aldi's entry into the Irish market, the other competing retailers seem to have adopted a dual approach to Aldi, cutting prices while downplaying the potential threat. Dunnes Stores have cut prices on five food staples although only in the stores located near Aldi. Tesco have acknowledged "some price adjustments" and Super Valu say they will "compete where they have it". Also, branding has become one of the core tasks of the supermarkets as it is beneficial to both the retailer and the consumer. For the retailer it generates profits and for the consumer it cuts down on decision making time as they are familiar with the standards associated with particular brands. Based on this evidence, perhaps the best way to avoid a price war in a small oligopolistic rivalry group is not to start one in the first place. If someone else does start a price war, the best response is simply to match the competition and then accentuate non-price elements by increasing services and by advertising brands.
Sandra Burke. (August 21, 2000) "Fears of grocery price war may prove unfounded." The Irish Times. Sean MacConnell. (November 25, 1999) "IFA says price war will damage producers." The Irish Times. Jack Fagan. (October 21, 1999) "Giant German food retailer to open beside ILAC." The Irish Times. |
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