SAMPLE FINAL QUESTIONS
PROBLEM 1: The Ananos family was in a tough spot. Shining Path guerrillas had just razed their family firm in southern Peru and were slowly strangling the nearby city of Ayacucho. But while the rest of Peru despaired at the Shining path’s campaign of terror in the late 1980’s, Eduardo and Mirtha Ananos spotted an opportunity. Rebels routinely hijacked trucks bringing Coca-‐Cola to the city, so the couple decided to start making cola in their backyard and sell it to the locals. Today, their company, Kola Real (KR), officially known as Industrias Ananos, is a fast growing South American company that offers no-‐
frill, ultra-‐low price cola in the Peruvian, Ecuadorian, and Venezuelan markets. Now they are deciding whether to enter the Mexican market or not. The facts below describe important aspects of the structure of this market and the decisions of the companies involved. Your answers must be based on these facts, and these facts only. Please do not appeal to either additional assumptions–unless you are specifically asked to do so—or to other facts you happen to know about this industry. FACTS: 1. In Mexico, Coca-‐Cola’s market share is 77% while PepsiCo’s is 23%. The Mexican market is the second largest, after the U.S., for Coca-‐Cola and accounts for $15 billion in revenue. Coke gets about 11% of its global profits and sales from Mexico. Femsa, the biggest bottler in Mexico and Coke’s No. 2 bottler world-‐wide has recorded annual rates of return of roughly 20% over the last decade – two or three times what Coke’s other big bottlers earn. 2. Mexico is “Coke country”: Mexicans drink more Coke per capita than anyone else in the world and their President at the time of this scenario, Vincente Fox, was a former head of Coke’s Mexican operations. By contrast, Mexicans typically see Pepsi as the low-‐end product and it is sold cheaper than Coke. Bodega owner Fernando Gracia Tapia stocks both Coke and Pepsi but his clientele of construction workers, waiters and maids clearly prefers Coke. Construction worker Raymundo Perez says, “I even have Coke for breakfast.” 3. Coke has historically relied on mom-‐and-‐pop stores or “bodegas”, like Mr. Garcia’s, as well as family-‐run restaurants to distribute its products. In fact, bodegas and restaurants account for nearly 75% of total soft drink sales in Mexico. Almost 90% of bodegas have a Coke cooler. Pepsi also has coolers in small stores but it has also relied on supermarkets to distribute its product. 4. Supermarkets account for less than 5% of sales in Mexico but they are the fastest-‐growing segment. Sam’s Club and Wal-‐Mart have also arrived in Mexico, increasing local awareness of prices and making consumers more value-‐conscious. 5. In the 1990s, sales of soft drinks switched to cheaper plastic from glass. Plastic bottles can also be sold in larger “family-‐friendly” units. 6. Brazil is the world’s third largest market for soft drinks. There so-‐called “B-‐brands” like Kola Real went from 3% of the market in the early 1990s to 30% now. The main channel of 1
Competitive Strategy and Industrial Structure
distribution in Brazil is supermarkets. 7.
Typical consumers of soft-‐drinks in Central and South America are low-‐income (like construction worker Raymundo Perez.) On average, they are poorer than counterparts in Europe and North America. QUESTIONS: Please answer these questions based only on the facts above 1-‐Were there any significant changes in the 1990’s that might have had an effect on the barriers to entry into this industry? Explain. (5 points) (Answers outside this box shall be ignored) 2-‐If Kola Real decides to enter the Mexican market should Pepsi respond by cutting its price aggressively? (10 points) (Answers outside this box shall be ignored) 3-‐If Kola Real decides to enter the Mexican market should Coke respond by cutting its price aggressively? (10 points) (Answers o utside this box shall be ignored) 2 Competitive Strategy and Industrial Structure
4-‐ A group of Coke executives is asking for your advice on non-‐price-‐based strategies to confront Kola Real’s entry into the Mexican market. Briefly present your recommendations. Avoid generic strategies such as “reduce cost,” “increase demand,” “collude with Pepsi” etc. You should stick to the facts above, and these facts only. (10 points) (Answers outside this box shall be ignored) 5-‐Coke and Pepsi are worried that the erosion of market share they experienced in Brazil could occur in the North American market. Is their worry justified? (5 points) (Answers outside this box shall be ignored) 3 Competitive Strategy and Industrial Structure
PROBLEM 2:
Suppose that two firms engage in differentiated-product price competition with demand functions
Q1=14-2P1+P2
Q2=14-2P2+P1
Both firms have a marginal cost of $2.
Derive the reaction functions of the two firms and the equilibrium prices. Show your main steps.
Firm 1’s reaction function ____________________________
Firm 2’s reaction function ____________________________
Firm 1’s equilibrium price ____________________________
Firm 2’s equilibrium price ____________________________
4 Competitive Strategy and Industrial Structure
PROBLEM 3:
You own a small chemicals firm that is considering entry into the propylene market in
Indonesia, a market that is currently monopolized by Shell Chemicals. The market
demand curve is Q = 12 – P, where P is the price and Q is annual demand (in units). If
both you and Shell set the same price, consumers will purchase from the incumbent
firm, Shell. If one firm has a lower price than the other, consumers will purchase from
the low-price firm, as long as the low-price firm can satisfy the resulting market
demand. If, however, because of capacity constraints, the low-price firm cannot satisfy
all of the market demand at the price that it sets, the higher-price firm’s demand is then
equal to:
12 – (Lower-Price Firm’s Capacity) - (Higher-Price Firm’s Price)
Your marginal cost of producing a unit of output is $3, while Shell’s marginal cost is $2.
(Your marginal cost includes the cost associated with building the necessary capacity to
produce your output). Shell currently has enough capacity to serve up to 12 units of
demand per year. You have just done a competitive analysis that has revealed the above
information. This analysis is discouraging: Shell can underprice you and still make a
profit. However, suppose that you choose a price equal to $4 and limit your capacity to 2
units.
1. What is Shell’s optimal choice of price and quantity given that you commit to a price
equal to $4 and you limit your capacity to 2 units?
2. In light of Shell’s optimal choice of price, what price should you commit to charge
given that you limit your capacity to 2 units?
5 Competitive Strategy and Industrial Structure
Answers
PROBLEM 1:
1.
Were there any significant changes in the 1990’s that might have had an effect on the barriers to
entry into this industry? Explain. (5 points)
Answers outside this box shall be ignored (Facts 5 and 4) The arrival of plastic bottles reduced entry costs. Also, the ability to make larger bottles and the arrival of Sam’s Club, etc. makes it easier to sell to price-‐sensitive customers. 2. If Kola Real decides to enter the Mexican market should Pepsi respond by cutting its price
aggressively? (10 points)
Answers outside this box shall be ignored (Facts 1, 2, 3 and 6) Pepsi is seen as the inferior product in Mexico and has small market share. It is also sold via the same distribution channels as KR. Hence, KR is potentially a Sumo competitor for Pepsi and a price-‐cut by Pepsi is warranted. In fact this is what actually happened – Pepsi cut prices aggressively. 3. If Kola Real decides to enter the Mexican market should Coke respond by cutting its price
aggressively? (10 points)
Answers outside this box shall be ignored (Facts 1, 2, 3 and 6) For Coke, the superior product, KR is less of a threat. Coke is also sold mainly through bodegas and small restaurants while KR is sold mainly through supermarkets. For Coke, KR is a Judo competitor and it is likely better to accommodate. In fact, Coke did not cut prices aggressively. 4. A group of Coke executives is asking for your advice on non-price-based strategies to confront Kola
Real’s entry into the Mexican market. Briefly present your recommendations. Avoid generic strategies
such as “reduce cost,” “increase demand,” “collude with Pepsi” etc. You should stick to the facts
above, and these facts only. (10 points)
Answers outside this box shall be ignored (Fact 3) Coke can try to prevent KR from supplying through mom-‐and-‐pop stores, which is the main distribution channel for soft drinks. This is in fact what Coke tried. This caught the attention of the Mexican anti-‐trust authority. 6 Competitive Strategy and Industrial Structure
5.
Coke and Pepsi are worried that the experience in Brazil means that the same erosion of market
share by entrants could occur in the North American market. Is their worry justified? (Recall that
you should base your answer only on the facts above) (5 points)
Answers outside this box shall be ignored (Facts 2, 6 and 7) Customers in North America are less price sensitive and hence there is less worry that the Brazilian experience could be replicated here. This question is based on a front page article in the Wall Street Journal on October 27, 2003.
PROBLEM 2:
Suppose that two firms engage in differentiated-product price competition with demand functions
Q1=14-2P1+P2
Q2=14-2P2+P1
Both firms have a marginal cost of $2.
Derive the reaction functions of the two firms and the equilibrium prices. Show your main steps.
Firm 1’s reaction function: P1 = 4.5 + 1/4 P2
Firm 2’s reaction function: P2 = 4.5 + 1/4 P1
Firm 1’s equilibrium price: 6
Firm 2’s equilibrium price: 6
Main steps:
Firm 1’s inverse demand is P1=7-0.5Q1+0.5P2, and hence MR is 7-Q1+0.5P2. We set MR equal to MC of 2
to get Q1=5 +0.5P2.
Substituting back into inverse demand we obtain Firm 1’s reaction function: P1 = 4.5 + 1/4 P2.
Similarly, we get that firm 2’s reaction function is P2 = 4.5 + 1/4 P1.
By solving the two reaction function equations simultaneously, we have: P1 = P2 = 6.
PROBLEM 3:
7 Competitive Strategy and Industrial Structure
1. Shell’s calculation:
Q = 12 – Capacity – P
Q = 12 – 2 – P
P = 10 – Q
MR = 10 – 2Q
MR = MC implies that 10 – 2Q = 2
Shell’s optimal quantity = 4 and Shell’s Optimal Price = 6
2. If you commit to a capacity of 2 units, you should charge a price equal to $4.99, or, in other words, just
undercut Shell’s price.
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