Task: Create and answer a case study similar to the Playmobil Case (Chapters 9-11) - Cases Available under Assignments tab on Blackboard that discusses retail price maintenance, credible threats and transfer pricing. Assigned to: Steven Speece
Final Summary...
Rolex Case Background. Luxury watchmaker Rolex USA was among 20 defendant Swiss watch companies named in a complaint by the US Department of Justice in 1954 as having conspired to engage in anti-competitive practices. The American Watch Association(AWA) of distributors, which was also named as a defendant claimed that Swiss watch manufacturers took active measures "to restrict, eliminate and discourage the manufacture of watches and watch parts in the United States, and to restrain United States imports and exports of watches and watch parts for manufacturing and repair purposes."
Potential Violations
Fixing minimum prices for watches and maximum prices for repair parts
Regulating the use and distribution of watches and repair parts
Boycotting those who violated these restrictions
The conspiracy came about through the adoption and enforcement of an agreement known as the Collective Convention of the Swiss Watch Industry. "The purpose of the Collective Convention was to protect, develop and stabilize the Swiss watch industry and to impede the growth of competitive watch industries outside of Switzerland." Rolex claimed in a statement to the court that prohibiting resale of repair parts or use of non-Rolex parts in Rolex watches was important to the quality assurance of its watches. Establishing exclusive regional distribution deals is not an anti-competitive practice, however no response was made to the allegations that certain distributors were "blacklisted" from any future relationship.
Market Impact of Rolex Policies
Retail price maintenance of the Swiss watch industry has secured its large market share since the 1950's. The Rolex brand has become ubiquitous the world over, however prices remain high, presumably well above marginal cost. A preponderance of evidence suggests that the prices consumers pay do not accurately reflect the actual free market supply and demand for these goods. By strictly controlling the distribution of watches and repair parts, Rolex is able to coerce distributors to not compete on price, deter creation of secondary markets, and suppress new entrants to the industry. To this extent, competition in the luxury watch industry has been constrained and suppressed. Watch retailers have been coerced into maintaining retail prices that maximize Rolex USA's profits rather than the profits of their own firms.
Final Judgement
Section VI.C of the Final Judgment states, in relevant part, that each defendant importer "is enjoined from. . . [r]estricting or controlling [t]he use by any person in the United States of watch parts or watchmaking machines purchased from" any defendant importer.
Section VI.H of the Final Judgment states that each defendant importer "is enjoined from . . . [e]ntering into any agreement or understanding with any reseller of watches, watch parts or watchmaking machines to fix or control the markup or the maximum or minimum price at which, the terms or conditions on which, or the customers to whom any such product may be resold."
Since 1996, Rolex's Policy Statement has included certain provisions that violate the Final Judgment.
One of the provisions in Rolex's Policy Statement, under the heading "Rolex Trademarks and Goodwill," states: "Parts may not be used in any watch that has non-Rolex parts or accessories (such as generic dials, bezels, crystals or bracelets)." This restriction on the ability of watchmakers to use parts purchased from Rolex to repair Rolex watches that have non-Rolex parts or accessories violates Section VI.C of the Final Judgment by limiting the use by watchmakers of the watch parts purchased from Rolex.
Another provision in Rolex's Policy Statement, under the heading "Terms of Sale," states: "Spare parts are sold for end use by the purchaser only. Spare parts may not be resold under any circumstances." This restriction on the ability to resell parts violates both Section VI.H of the Final Judgment by limiting the circumstances under which watch parts may be resold, and Section VI.C of the Final Judgment by limiting a watchmaker's use of the watch parts it purchases from Rolex.
A third provision in Rolex's Policy Statement, under the heading "General Policies," states: "To the extent that charges for spare parts are itemized, the markup shall not exceed fifty percent (50%)." This maximum pricing restriction violates Section VI.H of the Final Judgment by fixing the maximum markup that watchmakers can charge (when itemizing) for watch parts when performing repairs.
Since implementing each of these changes to its Policy Statement, Rolex has been in civil contempt for violating Sections VI.C and VI.H of the Final Judgment.
The court ordered Rolex to pay a fine for civil contempt of an unspecified amount
Rolex USA filed a motion to terminate judgement in 2006, tentatively agreed to by the Department of Justice.
Retail price maintenance is a strategy where suppliers of a good demand price floors or ceilings on their merchandise sold by retailers. Maintaining prices can deter retailers from entering price wars among each other or using the supplier's merchandise as a loss-leader, both of which can depress demand for the merchandise item. If Rolex retailers independently compete with each other on price to maximize profits, the overall profitability of Rolex USA would suffer. Price maintenance is particularly important for suppliers of luxury goods like Rolex wristwatches and jewelry to control the perceived value of their products. Maintaining a high retail price signals scarcity to the market whether or not the product is actually scarce.
Transfer Pricing refers to the way firms price the transfer of raw materials and goods between internal divisions of a company. If upstream divisions value goods or raw materials at a higher price than marginal cost in order to inflate performance metrics, downstream divisions will follow suit and the firm will suffer from double marginalization. In some cases internal divisions of a firm will lie across international borders; fluctuating currency exchange rates and different ad valorem tax codes can complicate efforts to keep double marginalization in check. Governments are particularly interested in transnational transfer pricing as it can determine the amount of tariffs collected on imported goods and materials. The optimal transfer price for a division or firm is generally calculated as the additional outlay costs incurred for the transfer plus the opportunity cost of not selling on the open market.
Credible threats refer to the punitive measures understood to be taken against a competing stakeholder in retaliation for non-cooperation, especially in regards to Prisoner's Dilemma economic scenarios. The credibility of a threat will depend largely on whether or not it is in the threatening party's best interest to carry out. A supplier threatening to terminate a relationship with a retailer with much market power like Walmart has little credibility. Threats are most credible when the capabilities to carry them out are demonstrable, and when the intent to carry them out under certain conditions is clearly understood. Firms with market power like Rolex are most capable of using credible threats to coerce retailers and suppliers.
References...
Baye, Michael R. Managerial Economics and Business Strategy, McGraw-Hill, New York, 2010, pp 417-419.
Hilton, Ronald W. Managerial Accounting: Creating Value in a Dynamic Business Environment, 9th Edition, McGraw-Hill, New York, 2011, pp 548-549.
Leung, Calvin. "Bling Sting." Canadian Business 82.6 (2009): 17-18. Academic Search Premier. Web. 5 Dec. 2011.
Liebeskind, David, "What Makes Rolex Tick?" Stern Business. http://w4.stern.nyu.edu/sternbusiness/fall_winter_2004/rolex.html, Winter 2004 Petition by the United States for an Order to Show Cause Why Rolex USA Inc. Should Not be Found in Civil Contempt.http://www.justice.gov/atr/cases/f214800/214820.htm United States of America vs. Watchmakers of Switzerland Information Center Inc. et. al.http://www.justice.gov/atr/cases/f214800/214816.htm
Quiz questions located at end of blog...
Playmobil Case Background."Geobra Brandstätter primarily molds plastic into popular playthings through its Playmobil unit. Germany's largest toy maker, it makes plastic figures (2.9 inches tall) with moveable heads, arms, and legs in various types of dress (construction workers, pirates, princesses, farmers, and nurses, among others). Geobra Brandstätter was founded in 1876; Playmobil in 1974. The company also makes accessories, such as vehicles, animals, and dollhouses. It licenses its name for products (books, CD-ROMs) and runs theme parks in France, Germany, Greece, Malta, and the US. Geobra Brandstätter operates subsidiaries in about a dozen countries, as well as production facilities in the Czech Republic, Germany, Malta, and Spain." -Google Finance http://www.google.com/finance?cid=9060965&hl=en
www.playmobil.com
The case brought against Playmobil in 1995 charged the firm with forcing retailers into maintaining minimum retail prices, which in effect precluded free market competition between retailers at the expense of consumers. The company allegedly colluded with major retailers in order to set prices and avoid price wars among US distributors. Playmobil was able to deter many retailers from undercutting MSRP through either direct or indirect competitive threats. In some cases Playmobil refused to fill orders from retailers who sold for below MSRP. On Transfer Pricing...
"Transfer pricing is a pricing strategy in which a firm optimally sets the internal price at which an upstream division sells an input to a downstream division." -Baye
Components of manufactured consumer goods may come from multiple sources, both internal and external. Sources of inputs are termed as "upstream" and outputs are "downstream." For example an engine manufacturing division is upstream from an automobile assembly line. The managers of each division of the firm will seek to maximize the profitability of their respective activity, however if the upstream division is charging more than marginal cost, the problem of double marginalization will arise. To avoid double marginalization and the resultant deadweight loss, prices must be synchronized across the supply chain to ensure profits are maximized for the firm, rather than an upstream division.
The overall profits of the firm are maximized when the marginal cost of upstream inputs equals the net marginal revenue to the downstream division.
References:
Baye, Michael R. Managerial Economics and Business Strategy, McGraw-Hill, New York, 2010, pp 417-419.
Exports and Transfer Pricing...
In today's globalized economy, multinational enterprises must navigate a complicated regimen of regulators in each sovereign country in which they operate. The international trade of goods and services is targeted by tariffs, customs duties, and ad valorem taxes. International trade treaties have codified some generally accepted transfer pricing practices to ensure goods and services are not double-taxed in such circumstances. Importing countries generally assess a tax on goods and services at the border based on market value. Exported goods and services are generally exempt from European Union Value Added Tax (VAT) but any overseas operating income could be subject to income taxes when that money returns home to Europe. The transfer price is the measure of value at customs that determines how much the importing country will collect in tariffs. The importing country has an incentive to inflate the transfer price as much as possible, whereas the exporting country typically prefers a lower transfer price to maximize their own revenue.Suppose Playmobil wanted to depress transfer prices in order to avoid paying tariffs and customs fees. In order to do that, enough independent distributors must drop their prices of identical products to change the interquartile range of prices for Playmobil products. It is not enough for one low-cost seller to undercut the competition. The U.S. tariff system is designed to prevent a foreign exporter like Playmobil from simply securing financial interest in a domestic distributor and artificially lowering the transfer price through collusion with a domestic front company. International trade operates on the 'Arm's Length Principle' in which transfer prices must be set according to what an independent importer at 'arm's length' from influence of the exporter would consider fair market value.Although in this case Playmobil does not appear to attempt to use its influence over distributors to depress transfer pricing at customs, the fact that Playmobil has pursued this kind of influence over distributors indicates it has little regard for the Arm's Length Principle. If Playmobil was found to alternately be manipulating prices in the other direction, they might have found themselves contending with tax evasion charges. To be fair, Playmobil's strategy is the product of a sophisticated and nuanced EU business environment. In EU countries, the VAT system has been a catalyst for vertical integration. Since transactions within a firm do not accrue VAT, European firms are less likely to outsource than their US counterparts. This may be a good or bad thing depending on who you ask. It also incentivizes suppliers to take an interest in maintaining consumer prices because sellers are responsible for paying VAT on the final transaction. References:EU Value Added Tax http://ec.europa.eu/taxation_customs/taxation/vat/how_vat_works/index_en.htm OECD: Transfer Pricing, Customs Duties, and VAT rules: can we bridge the gap? https://docs.google.com/viewer?url=http://www.oecd.org/dataoecd/40/54/39265412.pdf&embedded=true&chrome=trueBALACHANDRAN, K. R., SHU-HSING, L., TAYCHANG, W., & HSIAO-WEN, W. (2010). The Role of Transfer-Pricing Schemes in Coordinated Supply Chains. Journal of Accounting, Auditing & Finance, 25(3), 375-404. Retrieved from EBSCOhost. On Retail Price Maintenance.
True story! A couple years ago in 2008 I had just returned home from a 15 month tour of duty in Iraq. I had a bit of money in my pocket (from being single and not having to pay rent) and was looking to buy myself something I never had before: a nice wrist watch. Not just any watch, mind you- I wanted a Rolex. So I did some price research, and I was quite anxious to put to use all the haggling skills I had learned from my Arab friends. The housing market had just collapsed, the recession was in full swing, and this was theoretically the perfect time to shop for deals on luxury goods. There was much anecdotal evidence at the time that the demand for luxury items was declining. So rational retailers would respond by gradually lowering prices, right? Unfortunately, this is not the case. Reducing the price of a luxury good can reduce its perceived value to consumers which actually reduces demand. This is why Rolex zealously enforces seemingly arbitrary rules that have the effect of maintaining minimum pricing on retailers. If a jeweler is found to violate any Rolex terms, they risk losing their status as an Authorized Distributor. Rolex demands things like minimum store square footage (to inflate overhead, maybe?), display areas for their products, and even minimum sales volumes. Their demands are such that if an Authorized Distributor is found in contempt of any such pricing guidelines, Rolex can find some kind of contractual basis to end the distribution relationship without even mentioning price maintenance. Before a jeweler can become an Authorized Distributor, they must outlay a significant sum which becomes a sunk cost that gives the supplier even more leverage in the relationship.So what is a consumer to do in the event of such price manipulation? Rolex watches are quite durable goods; they are known to last decades. The secondary market is not subject to the same price maintenance pressures as the retail market. So you can go to a pawn shop, e-bay, craigslist, or other such venues to find yourself a Rolex, which may be worth the $3,000 you paid for it or it might be a $20 knock off. Jewelers are quite fond of bringing up the risks of such transactions. The only way to know for sure what you are getting is to take it to an authorized dealer or jeweler to get it appraised. An appraisal is not cheap. Although you could theoretically rendezvous with the seller at an Authorized Distributor and purchase it after the seller gets it appraised, the transaction costs are prohibitive to many private sellers. So by inflating the transaction costs and perceived risks of the secondary market, Rolex can also exert some pressures to maintain high market prices. I finally found a vintage watch dealer who had some non-vintage Rolex inventory. Although he was not a Rolex Authorized Distributor, he was an certified Rolex maintenance provider specializing in vintage models. Amazingly he claimed that he too had to abide by Rolex price minimums or he would risk losing his maintenance certification. In the end I was able to talk him down to my price; he did not lose his deal with Rolex to my knowledge. So I learned not only why Rolex watches are able to retain such high resale value, but how luxury goods suppliers insulate themselves from the effects of economic downturns through price maintenance strategies. References:Liebeskind, David, Stern Business. http://w4.stern.nyu.edu/sternbusiness/fall_winter_2004/rolex.html, Winter 2004
Elasticity, Secondary Markets, and Price Maintenance Are Playmobil toys luxury items? Certainly not. However, both toys and luxury goods markets have something in common in that they both are durable and have substantial secondary markets. The market for toys is by many accounts extremely elastic. Consumers have access to many substitute products should toy prices increase, including homemade crafts, or can forego purchasing new toys altogether for a prolonged period. Conversely, if toy prices were to be reduced (perhaps to account for drop in off-season demand) consumers can stockpile them for consumption during the next holiday season. Many online retailers are keenly aware of the temporal arbitrage profits to be made from toy suppliers looking to offload inventory after the holiday season. A cursory search of e-bay.com and amazon.com yielded several resellers who offered Playmobil products New and still In the Box (NIB). Toy suppliers like Playmobil which depend on strong holiday sales have reason to fear arbitrageurs like "Toy Hoarder" on Amazon.com competing with major retailers online. The secondary market for toys, like the secondary market for luxury goods, can significantly impact sales, especially to price-sensitive market segments. References:SYGEP'S STORE, e-Bay.com http://stores.ebay.com/SYGGEPS-STORE
Clair, John D., "Unwrapping the Hot-Toy Problem: An Analysis of Peak Demand and Price Dispersion in the Holiday Market for Zhu Zhu Pets" (2010). Economics Student Scholarship. http://scholar.oxy.edu/econ_student/2/
Tabarrok, Alexander. “The Hot-Toy Problem.” Journal of Economic Behavior and Organization. Pg. 512-516. Jan 2008
On Credible Threats... Sometimes suppliers and distributors have conflicting economic interests. For example, a retailer might use a supplier's product as a loss leader to boost sales in other products, but diminishing the perceived value of a supplier's product. Retailers might repackage and excessively bundle items, or create in-store promotions that hurt a product's sustainable sales growth prospects. How might a supplier deter a retailer from engaging in such activities without resorting to expensive and business-deterring legal contracts? Playmobil appears to use a threat credibility strategy not dissimilar to what Thomas Schelling referred to as "Salami Tactics." By breaking a large threat action into a sequence of small ones, much like slicing a salami, an opponent will quickly find non-cooperation to be counterproductive. Small and measured responses like overlooking errors in orders give stakeholders like Playmobil two major advantages. First by giving the distributor an opportunity to reconcile, Playmobil is not forced to immediately terminate sales relationships over small infractions in order to maintain the credibility of the threat. Secondly Playmobil can maintain plausible deniability if litigation was brought against the firm. An error in filling a sales order may just be an error. The supplier keeps the account open; yet signals are sent to the distributors that the relationship may be terminated or made unprofitable for the retailer. Schelling on Salami Tactics..."Salami tactics, we can be sure, were invented by a child.... Tell a child not to go in the water and he'll sit on the bank and submerge his bare feet; he is not yet 'in' the water. Acquiesce, and he'll stand up; no more of him is in the water than before. Think it over, and he'll start wading, not going any deeper; take a moment to decide whether this is different and he'll go a little deeper, arguing that since we goes back and forth it all averages out. Pretty soon we are calling to him not to swim out of sight, wondering whatever happened to all our discipline." To some observers, salami tactics on the part of a toy supplier might appear to be manipulative and unethical. However it should be pointed out that distributors are free at any time to terminate their accounts with Playmobil. The fact that the above mentioned mildly coercive measures do not result in distributors terminating relationships would indicate that retailers are better off cooperating with Playmobil than they would be if they were to simply stop carrying Playmobil products. Likewise if Playmobil was to quickly terminate relationships with distributors over in-store promotion conflicts as it is free to do, the supplier would risk harming its relationships with other distributors. It should also be noted that salami tactics were used to great effect by both sides during the Cold War. It is a powerful tool to engineer mechanisms of trust between two competing stakeholders. Salami tactics are not unlike 'tit for tat' strategies which ensure cooperation until defection occurs at which time each instance of defection is reciprocated. This may resemble the Old Testament saying 'an eye for an eye, tooth for a tooth.' Economist Robert Axelrod famously detailed in his book The Evolution of Cooperation the economic basis for the success of such strategies in business, politics, and biology. Axelrod conducted an iterative prisoner's dilemma tournament of strategies submitted by academics from all over the world. The consistently best performing strategy was 'tit for tat' in which cooperation is rewarded with cooperation and defection is punished with defection. This strategy has the advantages of simplicity, symmetry, and credibility, of which Playmobil makes great use in this case. References:Dixit, Avinash K. Nalebuff, Barry The Art of Strategy: A Game Theorist's Guide to Success in Business and Life, Pg.224-226Schelling, Thomas C. Arms and Influence, Yale University Press, 1966.Axelrod, Robert The Evolution of Cooperation, Basic Books, New York, 1981.
Credible Threats and Deterrence of New Entrants to the Market...
The Aluminum Company of America or Alcoa had controlled a majority of the aluminum market and bauxite suppliers in North America since the early part of the 20th century. An anti-trust case was brought against Alcoa in 1924 charging the company with blatantly violating the Sherman anti-trust act. Several years of litigation followed. When World War 2 broke out, aluminum was declared a strategic material and the case was put on hold. Meanwhile, time war-time demand for aluminum sky-rocketed and Alcoa's monopoly-critics charged them with not maintaining enough capacity and failing to anticipate war-time demand. Alcoa was able to rapidly expand capacity to meet demand (with government-leased properties), only to be forced to sell many leased facilities and capital equipment to rivals below-cost shortly after the war's end.
The resulting oligopoly of post-WW2 aluminum firms inherited a large amount of excess capacity; capital equipment in the industry is very lumpy and difficult to incrementally increase or idle. Regulators charged Alcoa with credibly deterring new entrants into the market by maintaining excess capacity and anticipating changes in market demand-- the same tactic that Alcoa was criticized for not practicing prior to the war. There are several views as to the efficacy of maintaining excess capacity as a credible threat, but disproving the hypothesis is difficult to do. In Lieberman's 1987 study of chemical manufacturers referenced below, both incumbent firms and new entrants made similar decisions regarding the maintenance of excess capacity.
"It was not inevitable that [Alcoa] should always anticipate increases in the demand for ingot and be prepared to supply them. Nothing compelled it to keep doubling and redoubling its capacity before others entered the field. It insists that it never excluded competitors; but we can think of no more effective exclusion than to progressively embrace each new opportunity as it opened, and to face every newcomer with new capacity already geared into a great organization, having the advantage of experience, trade connections and the elite of personnel." --Judge Learned Hand, U.S. vs. Alcoa, 1945
On Credible Commitments and Burning Bridges... In 1519 Hernan Cortes set off to become a great conquistador in the New World. After landing his forces at what is now known as Veracruz, Cortes was faced with dithering support from his subordinates and faced a potential mutiny by those wishing to return to the Spanish outpost in Cuba rather than face the Aztec empire. Cortes' legendary response was to scuttle his entire fleet of ships, eliminating any hope of defection by the potential mutineers. Of course Cortes went on to quickly conquer the Aztecs and acquire vast amounts of riches, but Cortes' men might have had little reason to believe in Cortes' resolve until he demonstrated his commitment to the goal. This strategy to communicate a credible commitment to other stakeholders is commonly called 'burning bridges.' By limiting one's own strategic options, a stakeholder can improve the utility of the outcome. Perhaps the ultimate example of this principle gone wrong is the 'Doomsday Machine' referenced in the 1964 film Dr. Strangelove or: How I learned to stop worrying and love the bomb. The Doomsday Machine would automatically destroy the entire world if either Soviet or US forces initiated a nuclear attack. By eliminating the possibility of stopping the Doomsday Machine once set in motion, the Soviets limited their own strategic options, but stood to ultimately gain by ending the costly arms race. In practice the tactic accidentally dooms the whole world after an accidental nuclear release. The film was a commentary about the moral hazards of Mutually Assured Destruction doctrine that succeeded in maintaining peace between the US and USSR for most of the Cold War. The film was intended as a dark comedy, but was based in fact as the Soviets did maintain somewhat of an automatic counter-strike capability with a system code-named DEAD HAND (Russian: Система Периметр). Because of the risk of unintentional activation, DEAD HAND was seldom left activated except in periods of heightened nuclear threat. Burning Bridges tactics are used in the business world perhaps more frequently than one might image, although to less dramatic effect than in the world of Dr. Strangelove. When a manager sends off an inflammatory e-mail to a delinquent supplier, carbon copying his staff and subordinates, the possibility for a future relationship with that supplier might be eliminated. This will limit the manager's options in the future for acquiring that critical input, however by signaling to the staff and other suppliers that threats to productivity will be dealt with decisively, the manager's commitment to budget and timeline has gained credibility. Perhaps the delinquent supplier was holding up completing a critical project. If the manager was to censure the supplier in private, the door might have been left open for later reconciliation, however by severing the relationship publicly the manager can not reconcile without suffering some damage to credibility. The principles at work are similar to those that give credibility to a marriage. Wedding vows are traditionally exchanged in the company of friends and family members. Because the commitment is made publicly, neither side can defect from the commitment without suffering some damage to their reputation and loss of credibility to future commitments. References:Hernán Cortés, marqués del Valle de Oaxaca http://www.britannica.com/EBchecked/topic/138839/Hernan-Cortes-marques-del-Valle-de-Oaxaca
WIRED, Soviet Doomsday Device Still Armed and Ready http://www.wired.com/wiredscience/2007/09/soviet-doomsday/Why You Might Want to Burn Bridges http://mindyourdecisions.com/blog/2008/06/17/why-you-might-want-to-burn-bridges/
Multiple Choice Questions...** 1. Which of the following is not a good reason for a supplier to pursue a retail price maintenance strategy?
(a) Avoid price wars among retailers.
(b) Resist arbitrageurs taking advantage of price fluctuations in seasonal goods.
(c) To maximize a product's utility to consumers
(d) Maintain a product image of high value (e.g. for luxury goods)
2. Which of the following is not characteristic of a credible threat?
(a) The threat is within the threatening party's best interest to carry out.
(b) The threat if carried out would be financially disastrous for all stakeholders.
(c) The threatened capability is clearly understood and preceded by demonstrated capability
(d) None of the above
3. When might a multinational firm seek to deflate transfer prices of input goods?
(a) When taxes are relatively higher in the importing country.
(b) When taxes are relatively higher in the exporting country.
(c) When the exporting country has a higher capital gains tax than the importing country
(d) None of the above. 4. What factor might make maintaining excess production capacity a particularly credible threat to deter new entrants?(a) Variable costs of production are high (b) Fixed costs of expanding production capacity is low and variable costs of production are high.(c) Fixed costs of expanding production capacity is high and variable costs of production are low.(d) The cost of labor is low 5. What situation is most likely to lead to double marginalization?(a) High consumer prices(b) Firms have little market power(c) Upstream suppliers charging below marginal cost(d) Two independent firms exist with a supplier-retailer relationship, and both have market power Answers
1. c - Price maintenance strategies may change a product's perceived value to consumers, but the utility of the product remains unchanged.
2. b - A threat does not need to be potentially disastrous to all parties to be credible.
3. a - Trade goods are taxed on assessed value by the importing country, therefore exporters would deflate transfer prices in order to avoid paying higher taxes.4. c - If fixed costs are high and variable costs are low then the marginal cost of production for the incumbent firm will be lower.5. d - Double marginalization occurs when two agents in the same supply chain charge prices higher than marginal cost
Assigned to: Steven Speece
Final Summary...
Rolex Case Background. Luxury watchmaker Rolex USA was among 20 defendant Swiss watch companies named in a complaint by the US Department of Justice in 1954 as having conspired to engage in anti-competitive practices. The American Watch Association(AWA) of distributors, which was also named as a defendant claimed that Swiss watch manufacturers took active measures "to restrict, eliminate and discourage the manufacture of watches and watch parts in the United States, and to restrain United States imports and exports of watches and watch parts for manufacturing and repair purposes."
The conspiracy came about through the adoption and enforcement of an agreement known as the Collective Convention of the Swiss Watch Industry. "The purpose of the Collective Convention was to protect, develop and stabilize the Swiss watch industry and to impede the growth of competitive watch industries outside of Switzerland." Rolex claimed in a statement to the court that prohibiting resale of repair parts or use of non-Rolex parts in Rolex watches was important to the quality assurance of its watches. Establishing exclusive regional distribution deals is not an anti-competitive practice, however no response was made to the allegations that certain distributors were "blacklisted" from any future relationship.
Market Impact of Rolex Policies
Retail price maintenance of the Swiss watch industry has secured its large market share since the 1950's. The Rolex brand has become ubiquitous the world over, however prices remain high, presumably well above marginal cost. A preponderance of evidence suggests that the prices consumers pay do not accurately reflect the actual free market supply and demand for these goods. By strictly controlling the distribution of watches and repair parts, Rolex is able to coerce distributors to not compete on price, deter creation of secondary markets, and suppress new entrants to the industry. To this extent, competition in the luxury watch industry has been constrained and suppressed. Watch retailers have been coerced into maintaining retail prices that maximize Rolex USA's profits rather than the profits of their own firms.
Final Judgement
- Section VI.C of the Final Judgment states, in relevant part, that each defendant importer "is enjoined from. . . [r]estricting or controlling [t]he use by any person in the United States of watch parts or watchmaking machines purchased from" any defendant importer.
- Section VI.H of the Final Judgment states that each defendant importer "is enjoined from . . . [e]ntering into any agreement or understanding with any reseller of watches, watch parts or watchmaking machines to fix or control the markup or the maximum or minimum price at which, the terms or conditions on which, or the customers to whom any such product may be resold."
Since 1996, Rolex's Policy Statement has included certain provisions that violate the Final Judgment.- One of the provisions in Rolex's Policy Statement, under the heading "Rolex Trademarks and Goodwill," states: "Parts may not be used in any watch that has non-Rolex parts or accessories (such as generic dials, bezels, crystals or bracelets)." This restriction on the ability of watchmakers to use parts purchased from Rolex to repair Rolex watches that have non-Rolex parts or accessories violates Section VI.C of the Final Judgment by limiting the use by watchmakers of the watch parts purchased from Rolex.
- Another provision in Rolex's Policy Statement, under the heading "Terms of Sale," states: "Spare parts are sold for end use by the purchaser only. Spare parts may not be resold under any circumstances." This restriction on the ability to resell parts violates both Section VI.H of the Final Judgment by limiting the circumstances under which watch parts may be resold, and Section VI.C of the Final Judgment by limiting a watchmaker's use of the watch parts it purchases from Rolex.
- A third provision in Rolex's Policy Statement, under the heading "General Policies," states: "To the extent that charges for spare parts are itemized, the markup shall not exceed fifty percent (50%)." This maximum pricing restriction violates Section VI.H of the Final Judgment by fixing the maximum markup that watchmakers can charge (when itemizing) for watch parts when performing repairs.
Since implementing each of these changes to its Policy Statement, Rolex has been in civil contempt for violating Sections VI.C and VI.H of the Final Judgment.Retail price maintenance is a strategy where suppliers of a good demand price floors or ceilings on their merchandise sold by retailers. Maintaining prices can deter retailers from entering price wars among each other or using the supplier's merchandise as a loss-leader, both of which can depress demand for the merchandise item. If Rolex retailers independently compete with each other on price to maximize profits, the overall profitability of Rolex USA would suffer. Price maintenance is particularly important for suppliers of luxury goods like Rolex wristwatches and jewelry to control the perceived value of their products. Maintaining a high retail price signals scarcity to the market whether or not the product is actually scarce.
Transfer Pricing refers to the way firms price the transfer of raw materials and goods between internal divisions of a company. If upstream divisions value goods or raw materials at a higher price than marginal cost in order to inflate performance metrics, downstream divisions will follow suit and the firm will suffer from double marginalization. In some cases internal divisions of a firm will lie across international borders; fluctuating currency exchange rates and different ad valorem tax codes can complicate efforts to keep double marginalization in check. Governments are particularly interested in transnational transfer pricing as it can determine the amount of tariffs collected on imported goods and materials. The optimal transfer price for a division or firm is generally calculated as the additional outlay costs incurred for the transfer plus the opportunity cost of not selling on the open market.
Credible threats refer to the punitive measures understood to be taken against a competing stakeholder in retaliation for non-cooperation, especially in regards to Prisoner's Dilemma economic scenarios. The credibility of a threat will depend largely on whether or not it is in the threatening party's best interest to carry out. A supplier threatening to terminate a relationship with a retailer with much market power like Walmart has little credibility. Threats are most credible when the capabilities to carry them out are demonstrable, and when the intent to carry them out under certain conditions is clearly understood. Firms with market power like Rolex are most capable of using credible threats to coerce retailers and suppliers.
References...
Baye, Michael R. Managerial Economics and Business Strategy, McGraw-Hill, New York, 2010, pp 417-419.
Hilton, Ronald W. Managerial Accounting: Creating Value in a Dynamic Business Environment, 9th Edition, McGraw-Hill, New York, 2011, pp 548-549.
Leung, Calvin. "Bling Sting." Canadian Business 82.6 (2009): 17-18. Academic Search Premier. Web. 5 Dec. 2011.
Liebeskind, David, "What Makes Rolex Tick?" Stern Business. http://w4.stern.nyu.edu/sternbusiness/fall_winter_2004/rolex.html, Winter 2004
Petition by the United States for an Order to Show Cause Why Rolex USA Inc. Should Not be Found in Civil Contempt. http://www.justice.gov/atr/cases/f214800/214820.htm
United States of America vs. Watchmakers of Switzerland Information Center Inc. et. al. http://www.justice.gov/atr/cases/f214800/214816.htm
Quiz questions located at end of blog...
Playmobil Case Background. "Geobra Brandstätter primarily molds plastic into popular playthings through its Playmobil unit. Germany's largest toy maker, it makes plastic figures (2.9 inches tall) with moveable heads, arms, and legs in various types of dress (construction workers, pirates, princesses, farmers, and nurses, among others). Geobra Brandstätter was founded in 1876; Playmobil in 1974. The company also makes accessories, such as vehicles, animals, and dollhouses. It licenses its name for products (books, CD-ROMs) and runs theme parks in France, Germany, Greece, Malta, and the US. Geobra Brandstätter operates subsidiaries in about a dozen countries, as well as production facilities in the Czech Republic, Germany, Malta, and Spain." -Google Finance http://www.google.com/finance?cid=9060965&hl=en
The case brought against Playmobil in 1995 charged the firm with forcing retailers into maintaining minimum retail prices, which in effect precluded free market competition between retailers at the expense of consumers. The company allegedly colluded with major retailers in order to set prices and avoid price wars among US distributors. Playmobil was able to deter many retailers from undercutting MSRP through either direct or indirect competitive threats. In some cases Playmobil refused to fill orders from retailers who sold for below MSRP.
On Transfer Pricing...
"Transfer pricing is a pricing strategy in which a firm optimally sets the internal price at which an upstream division sells an input to a downstream division." -Baye
Components of manufactured consumer goods may come from multiple sources, both internal and external. Sources of inputs are termed as "upstream" and outputs are "downstream." For example an engine manufacturing division is upstream from an automobile assembly line. The managers of each division of the firm will seek to maximize the profitability of their respective activity, however if the upstream division is charging more than marginal cost, the problem of double marginalization will arise. To avoid double marginalization and the resultant deadweight loss, prices must be synchronized across the supply chain to ensure profits are maximized for the firm, rather than an upstream division.
References:
Baye, Michael R. Managerial Economics and Business Strategy, McGraw-Hill, New York, 2010, pp 417-419.
Exports and Transfer Pricing...
In today's globalized economy, multinational enterprises must navigate a complicated regimen of regulators in each sovereign country in which they operate. The international trade of goods and services is targeted by tariffs, customs duties, and ad valorem taxes. International trade treaties have codified some generally accepted transfer pricing practices to ensure goods and services are not double-taxed in such circumstances. Importing countries generally assess a tax on goods and services at the border based on market value. Exported goods and services are generally exempt from European Union Value Added Tax (VAT) but any overseas operating income could be subject to income taxes when that money returns home to Europe. The transfer price is the measure of value at customs that determines how much the importing country will collect in tariffs. The importing country has an incentive to inflate the transfer price as much as possible, whereas the exporting country typically prefers a lower transfer price to maximize their own revenue.Suppose Playmobil wanted to depress transfer prices in order to avoid paying tariffs and customs fees. In order to do that, enough independent distributors must drop their prices of identical products to change the interquartile range of prices for Playmobil products. It is not enough for one low-cost seller to undercut the competition. The U.S. tariff system is designed to prevent a foreign exporter like Playmobil from simply securing financial interest in a domestic distributor and artificially lowering the transfer price through collusion with a domestic front company. International trade operates on the 'Arm's Length Principle' in which transfer prices must be set according to what an independent importer at 'arm's length' from influence of the exporter would consider fair market value.Although in this case Playmobil does not appear to attempt to use its influence over distributors to depress transfer pricing at customs, the fact that Playmobil has pursued this kind of influence over distributors indicates it has little regard for the Arm's Length Principle. If Playmobil was found to alternately be manipulating prices in the other direction, they might have found themselves contending with tax evasion charges. To be fair, Playmobil's strategy is the product of a sophisticated and nuanced EU business environment. In EU countries, the VAT system has been a catalyst for vertical integration. Since transactions within a firm do not accrue VAT, European firms are less likely to outsource than their US counterparts. This may be a good or bad thing depending on who you ask. It also incentivizes suppliers to take an interest in maintaining consumer prices because sellers are responsible for paying VAT on the final transaction.
References:EU Value Added Tax http://ec.europa.eu/taxation_customs/taxation/vat/how_vat_works/index_en.htm
OECD: Transfer Pricing, Customs Duties, and VAT rules: can we bridge the gap? https://docs.google.com/viewer?url=http://www.oecd.org/dataoecd/40/54/39265412.pdf&embedded=true&chrome=trueBALACHANDRAN, K. R., SHU-HSING, L., TAYCHANG, W., & HSIAO-WEN, W. (2010). The Role of Transfer-Pricing Schemes in Coordinated Supply Chains. Journal of Accounting, Auditing & Finance, 25(3), 375-404. Retrieved from EBSCOhost.
On Retail Price Maintenance.
True story! A couple years ago in 2008 I had just returned home from a 15 month tour of duty in Iraq. I had a bit of money in my pocket (from being single and not having to pay rent) and was looking to buy myself something I never had before: a nice wrist watch. Not just any watch, mind you- I wanted a Rolex. So I did some price research, and I was quite anxious to put to use all the haggling skills I had learned from my Arab friends. The housing market had just collapsed, the recession was in full swing, and this was theoretically the perfect time to shop for deals on luxury goods.
There was much anecdotal evidence at the time that the demand for luxury items was declining. So rational retailers would respond by gradually lowering prices, right? Unfortunately, this is not the case. Reducing the price of a luxury good can reduce its perceived value to consumers which actually reduces demand. This is why Rolex zealously enforces seemingly arbitrary rules that have the effect of maintaining minimum pricing on retailers. If a jeweler is found to violate any Rolex terms, they risk losing their status as an Authorized Distributor. Rolex demands things like minimum store square footage (to inflate overhead, maybe?), display areas for their products, and even minimum sales volumes. Their demands are such that if an Authorized Distributor is found in contempt of any such pricing guidelines, Rolex can find some kind of contractual basis to end the distribution relationship without even mentioning price maintenance. Before a jeweler can become an Authorized Distributor, they must outlay a significant sum which becomes a sunk cost that gives the supplier even more leverage in the relationship.So what is a consumer to do in the event of such price manipulation? Rolex watches are quite durable goods; they are known to last decades. The secondary market is not subject to the same price maintenance pressures as the retail market. So you can go to a pawn shop, e-bay, craigslist, or other such venues to find yourself a Rolex, which may be worth the $3,000 you paid for it or it might be a $20 knock off. Jewelers are quite fond of bringing up the risks of such transactions. The only way to know for sure what you are getting is to take it to an authorized dealer or jeweler to get it appraised. An appraisal is not cheap. Although you could theoretically rendezvous with the seller at an Authorized Distributor and purchase it after the seller gets it appraised, the transaction costs are prohibitive to many private sellers. So by inflating the transaction costs and perceived risks of the secondary market, Rolex can also exert some pressures to maintain high market prices. I finally found a vintage watch dealer who had some non-vintage Rolex inventory. Although he was not a Rolex Authorized Distributor, he was an certified Rolex maintenance provider specializing in vintage models. Amazingly he claimed that he too had to abide by Rolex price minimums or he would risk losing his maintenance certification. In the end I was able to talk him down to my price; he did not lose his deal with Rolex to my knowledge. So I learned not only why Rolex watches are able to retain such high resale value, but how luxury goods suppliers insulate themselves from the effects of economic downturns through price maintenance strategies.
References:Liebeskind, David, Stern Business. http://w4.stern.nyu.edu/sternbusiness/fall_winter_2004/rolex.html, Winter 2004
Elasticity, Secondary Markets, and Price Maintenance
Are Playmobil toys luxury items? Certainly not. However, both toys and luxury goods markets have something in common in that they both are durable and have substantial secondary markets. The market for toys is by many accounts extremely elastic. Consumers have access to many substitute products should toy prices increase, including homemade crafts, or can forego purchasing new toys altogether for a prolonged period. Conversely, if toy prices were to be reduced (perhaps to account for drop in off-season demand) consumers can stockpile them for consumption during the next holiday season. Many online retailers are keenly aware of the temporal arbitrage profits to be made from toy suppliers looking to offload inventory after the holiday season. A cursory search of e-bay.com and amazon.com yielded several resellers who offered Playmobil products New and still In the Box (NIB). Toy suppliers like Playmobil which depend on strong holiday sales have reason to fear arbitrageurs like "Toy Hoarder" on Amazon.com competing with major retailers online. The secondary market for toys, like the secondary market for luxury goods, can significantly impact sales, especially to price-sensitive market segments.
References:SYGEP'S STORE, e-Bay.com http://stores.ebay.com/SYGGEPS-STORE
Clair, John D., "Unwrapping the Hot-Toy Problem: An Analysis of Peak Demand and Price Dispersion in the Holiday Market for Zhu Zhu Pets" (2010). Economics Student Scholarship.
http://scholar.oxy.edu/econ_student/2/
Tabarrok, Alexander. “The Hot-Toy Problem.” Journal of Economic Behavior and Organization. Pg. 512-516. Jan 2008
On Credible Threats...
Sometimes suppliers and distributors have conflicting economic interests. For example, a retailer might use a supplier's product as a loss leader to boost sales in other products, but diminishing the perceived value of a supplier's product. Retailers might repackage and excessively bundle items, or create in-store promotions that hurt a product's sustainable sales growth prospects. How might a supplier deter a retailer from engaging in such activities without resorting to expensive and business-deterring legal contracts?
Playmobil appears to use a threat credibility strategy not dissimilar to what Thomas Schelling referred to as "Salami Tactics." By breaking a large threat action into a sequence of small ones, much like slicing a salami, an opponent will quickly find non-cooperation to be counterproductive. Small and measured responses like overlooking errors in orders give stakeholders like Playmobil two major advantages. First by giving the distributor an opportunity to reconcile, Playmobil is not forced to immediately terminate sales relationships over small infractions in order to maintain the credibility of the threat. Secondly Playmobil can maintain plausible deniability if litigation was brought against the firm. An error in filling a sales order may just be an error. The supplier keeps the account open; yet signals are sent to the distributors that the relationship may be terminated or made unprofitable for the retailer.
Schelling on Salami Tactics..."Salami tactics, we can be sure, were invented by a child.... Tell a child not to go in the water and he'll sit on the bank and submerge his bare feet; he is not yet 'in' the water. Acquiesce, and he'll stand up; no more of him is in the water than before. Think it over, and he'll start wading, not going any deeper; take a moment to decide whether this is different and he'll go a little deeper, arguing that since we goes back and forth it all averages out. Pretty soon we are calling to him not to swim out of sight, wondering whatever happened to all our discipline."
To some observers, salami tactics on the part of a toy supplier might appear to be manipulative and unethical. However it should be pointed out that distributors are free at any time to terminate their accounts with Playmobil. The fact that the above mentioned mildly coercive measures do not result in distributors terminating relationships would indicate that retailers are better off cooperating with Playmobil than they would be if they were to simply stop carrying Playmobil products. Likewise if Playmobil was to quickly terminate relationships with distributors over in-store promotion conflicts as it is free to do, the supplier would risk harming its relationships with other distributors.
It should also be noted that salami tactics were used to great effect by both sides during the Cold War. It is a powerful tool to engineer mechanisms of trust between two competing stakeholders. Salami tactics are not unlike 'tit for tat' strategies which ensure cooperation until defection occurs at which time each instance of defection is reciprocated. This may resemble the Old Testament saying 'an eye for an eye, tooth for a tooth.' Economist Robert Axelrod famously detailed in his book The Evolution of Cooperation the economic basis for the success of such strategies in business, politics, and biology. Axelrod conducted an iterative prisoner's dilemma tournament of strategies submitted by academics from all over the world. The consistently best performing strategy was 'tit for tat' in which cooperation is rewarded with cooperation and defection is punished with defection. This strategy has the advantages of simplicity, symmetry, and credibility, of which Playmobil makes great use in this case.
References:Dixit, Avinash K. Nalebuff, Barry The Art of Strategy: A Game Theorist's Guide to Success in Business and Life, Pg.224-226Schelling, Thomas C. Arms and Influence, Yale University Press, 1966.Axelrod, Robert The Evolution of Cooperation, Basic Books, New York, 1981.
Credible Threats and Deterrence of New Entrants to the Market...
The Aluminum Company of America or Alcoa had controlled a majority of the aluminum market and bauxite suppliers in North America since the early part of the 20th century. An anti-trust case was brought against Alcoa in 1924 charging the company with blatantly violating the Sherman anti-trust act. Several years of litigation followed. When World War 2 broke out, aluminum was declared a strategic material and the case was put on hold. Meanwhile, time war-time demand for aluminum sky-rocketed and Alcoa's monopoly-critics charged them with not maintaining enough capacity and failing to anticipate war-time demand. Alcoa was able to rapidly expand capacity to meet demand (with government-leased properties), only to be forced to sell many leased facilities and capital equipment to rivals below-cost shortly after the war's end.
The resulting oligopoly of post-WW2 aluminum firms inherited a large amount of excess capacity; capital equipment in the industry is very lumpy and difficult to incrementally increase or idle. Regulators charged Alcoa with credibly deterring new entrants into the market by maintaining excess capacity and anticipating changes in market demand-- the same tactic that Alcoa was criticized for not practicing prior to the war. There are several views as to the efficacy of maintaining excess capacity as a credible threat, but disproving the hypothesis is difficult to do. In Lieberman's 1987 study of chemical manufacturers referenced below, both incumbent firms and new entrants made similar decisions regarding the maintenance of excess capacity.
"It was not inevitable that [Alcoa] should always anticipate increases in the demand for ingot and be prepared to supply them. Nothing compelled it to keep doubling and redoubling its capacity before others entered the field. It insists that it never excluded competitors; but we can think of no more effective exclusion than to progressively embrace each new opportunity as it opened, and to face every newcomer with new capacity already geared into a great organization, having the advantage of experience, trade connections and the elite of personnel." --Judge Learned Hand, U.S. vs. Alcoa, 1945
Although Alcoa's market share is now significantly diminished by foreign competition and some long-term idled plants were recently shut down, Alcoa still maintains some excess capacity. There are currently several idle pot-lines in domestic smelting plants that could be quickly restored to full operation.
References:
Alcoa History http://www.alcoa.com/usa/en/alcoa_usa/history.asp
Alcoa Current Smelting Capacity http://www.alcoa.com/primary_eu/en/alcoa_primary_eu/capacity.asp#
Lieberman, Marvin "Excess Capacity as a Barrier to Entry: A Critical Appraisal" Journal of Industrial Economics, June 1987
https://docs.google.com/viewer?url=http://www.anderson.ucla.edu/faculty/marvin.lieberman/publications/ExcessCapBarrierEntry-JIE1987.pdf&embedded=true&chrome=true
On Credible Commitments and Burning Bridges...
In 1519 Hernan Cortes set off to become a great conquistador in the New World. After landing his forces at what is now known as Veracruz, Cortes was faced with dithering support from his subordinates and faced a potential mutiny by those wishing to return to the Spanish outpost in Cuba rather than face the Aztec empire. Cortes' legendary response was to scuttle his entire fleet of ships, eliminating any hope of defection by the potential mutineers. Of course Cortes went on to quickly conquer the Aztecs and acquire vast amounts of riches, but Cortes' men might have had little reason to believe in Cortes' resolve until he demonstrated his commitment to the goal. This strategy to communicate a credible commitment to other stakeholders is commonly called 'burning bridges.' By limiting one's own strategic options, a stakeholder can improve the utility of the outcome.
Perhaps the ultimate example of this principle gone wrong is the 'Doomsday Machine' referenced in the 1964 film Dr. Strangelove or: How I learned to stop worrying and love the bomb. The Doomsday Machine would automatically destroy the entire world if either Soviet or US forces initiated a nuclear attack. By eliminating the possibility of stopping the Doomsday Machine once set in motion, the Soviets limited their own strategic options, but stood to ultimately gain by ending the costly arms race. In practice the tactic accidentally dooms the whole world after an accidental nuclear release. The film was a commentary about the moral hazards of Mutually Assured Destruction doctrine that succeeded in maintaining peace between the US and USSR for most of the Cold War. The film was intended as a dark comedy, but was based in fact as the Soviets did maintain somewhat of an automatic counter-strike capability with a system code-named DEAD HAND (Russian: Система Периметр). Because of the risk of unintentional activation, DEAD HAND was seldom left activated except in periods of heightened nuclear threat.
Burning Bridges tactics are used in the business world perhaps more frequently than one might image, although to less dramatic effect than in the world of Dr. Strangelove. When a manager sends off an inflammatory e-mail to a delinquent supplier, carbon copying his staff and subordinates, the possibility for a future relationship with that supplier might be eliminated. This will limit the manager's options in the future for acquiring that critical input, however by signaling to the staff and other suppliers that threats to productivity will be dealt with decisively, the manager's commitment to budget and timeline has gained credibility. Perhaps the delinquent supplier was holding up completing a critical project. If the manager was to censure the supplier in private, the door might have been left open for later reconciliation, however by severing the relationship publicly the manager can not reconcile without suffering some damage to credibility.
The principles at work are similar to those that give credibility to a marriage. Wedding vows are traditionally exchanged in the company of friends and family members. Because the commitment is made publicly, neither side can defect from the commitment without suffering some damage to their reputation and loss of credibility to future commitments.
References:Hernán Cortés, marqués del Valle de Oaxaca http://www.britannica.com/EBchecked/topic/138839/Hernan-Cortes-marques-del-Valle-de-Oaxaca
WIRED, Soviet Doomsday Device Still Armed and Ready http://www.wired.com/wiredscience/2007/09/soviet-doomsday/Why You Might Want to Burn Bridges http://mindyourdecisions.com/blog/2008/06/17/why-you-might-want-to-burn-bridges/
Multiple Choice Questions...**
1. Which of the following is not a good reason for a supplier to pursue a retail price maintenance strategy?
(a) Avoid price wars among retailers.
(b) Resist arbitrageurs taking advantage of price fluctuations in seasonal goods.
(c) To maximize a product's utility to consumers
(d) Maintain a product image of high value (e.g. for luxury goods)
2. Which of the following is not characteristic of a credible threat?
(a) The threat is within the threatening party's best interest to carry out.
(b) The threat if carried out would be financially disastrous for all stakeholders.
(c) The threatened capability is clearly understood and preceded by demonstrated capability
(d) None of the above
3. When might a multinational firm seek to deflate transfer prices of input goods?
(a) When taxes are relatively higher in the importing country.
(b) When taxes are relatively higher in the exporting country.
(c) When the exporting country has a higher capital gains tax than the importing country
(d) None of the above.
4. What factor might make maintaining excess production capacity a particularly credible threat to deter new entrants?(a) Variable costs of production are high
(b) Fixed costs of expanding production capacity is low and variable costs of production are high.(c) Fixed costs of expanding production capacity is high and variable costs of production are low.(d) The cost of labor is low
5. What situation is most likely to lead to double marginalization?(a) High consumer prices(b) Firms have little market power(c) Upstream suppliers charging below marginal cost(d) Two independent firms exist with a supplier-retailer relationship, and both have market power
Answers
1. c - Price maintenance strategies may change a product's perceived value to consumers, but the utility of the product remains unchanged.
2. b - A threat does not need to be potentially disastrous to all parties to be credible.
3. a - Trade goods are taxed on assessed value by the importing country, therefore exporters would deflate transfer prices in order to avoid paying higher taxes.4. c - If fixed costs are high and variable costs are low then the marginal cost of production for the incumbent firm will be lower.5. d - Double marginalization occurs when two agents in the same supply chain charge prices higher than marginal cost