The Marketing Book 5th Edition

£50

C

ompetitor B

Less than £50

Competitor A

£50 Less than £50

³ 0

³ 0

200 £ 390

200

£ 390

In each quadrant, the top right payoff is for

competitor A and the bottom left for B. Circles

indicate the payoff that is the best outcome for

that player given the strategy of the other.

0

306 The Marketing Book

likely to drop substantially below £49. In fact, at
any price higher than £10, the two competitors
can improve their individual situation by
undercutting the other and obtaining the entire
contract.
Only when both competitors are charging
£10, and just making the minimum return
necessary to stay in the market, is there no
incentive for either to undercut the other. In the
language of game theory, £10 is the only Nash
equilibrium of this game – the only price at
which neither competitor can individually
improve its own situation by reducing prices.
But if the two competitors are charging £10,
they are both much worse off than they could
have been if they had shared the contract at
£50.
The Prisoner’s Dilemma game is a simpli-
fied model of price competition, but it does
highlight a conclusion that holds generally.
That is, the individual incentive to cut prices
can lead to consequences that leave every

competitor worse off. This result, however,

does not always occur. The most important

oversimplification of the model is that it is a

one-off, static decision. In practice, competitors

can usually react to each other’s price deci-

sions. If a competitor anticipates that his rival

will respond, then he may not engage in price

competition. Take a simple example of a town

with two petrol stations next to each other and

customers purely interested in getting the

cheapest petrol. To begin with, assume that

both are charging the monopoly price – that

price which maximizes the joint profits of the

two stations. What happens if competitor A

lowers its price by 1p a litre? Competitor B,

knowing that a price disadvantage will drive

his market share to zero, is bound to imme-

diately follow A’s price down. Anticipating that

this will happen, station A should not lower its

price in the first place. The outcome of antici-

pating a competitive reaction is the exact

opposite of the Prisoner’s Dilemma – monop-

oly pricing, rather than competitive pricing.

Note that it is easy to predict a co-operative

rather than a competitive price outcome in the

petrol station example, because of the assump-

tions that were made. These include: price

starts at the monopoly level; both competitors

implicitly agree what this level is; information

about prices is available immediately and

without cost to both competitors and con-

sumers; there are only two competitors and no

substitutes for the commodity. However, most

markets have more complex features than the

petrol station example, making predictions

about prices more difficult. The key to antici-

pating competitive pricing behaviour is to look

at the characteristics of the industry.

Implementing pricing strategy

Just as accountants tend to be biased in favour of

high prices, marketers tend to favour low prices.

The latter is in part due to their focus on cus-

tomer satisfaction and market share. It is also

often due to the incentive structures that reward

marketers for achieving volume rather than

Figure 11.6 Pricing and the Prisoner’s Dilemma.