raising+rivals+costs

=Raising Rivals' Costs= Fenstermaker, Eric Bittle, Curtis

The strategy referred to as raising rivals' costs is just that, a strategy in which an existing firm gains leverage over its rivals by raising the rivals costs. This strategy lends itself better to dominant firms.

When a firm practices this competition-eliminating strategy, the decision-making abilities of its rivals are lessened. So, "by increasing rivals' costs, a firm distorts rivals' decision-making incentives, and this can ultimately affect their prices, output, and entry decisions."¹

There are three primary ways to raise rivals' costs.
 * 1) increase the marginal cost
 * 2) affect the fixed costs
 * 3) strengthen the firm by developing more vertical integration

**Marginal Cost**
By raising rivals' marginal cost a firm can benefit in two ways; To illustrate this concept, consider two firms producing at the same level--Firms Y & Z. If firm Y successfully manages to raise the MC of firm Z, firm Z will need to lower its production output to offset the losses caused by the change in the marginal cost. In turn this will lower their ability to maintain market share and earn higher profits. Graphically this is shown by a leftward or downward shift in the isoprofit curve. Once firm Z reduces output, firm Y's market share and profits increase, moving closer to a monopolistic pofit. See also: Marginal Analysis - Marginal Benefit including Marginal revenue and Marginal cost
 * increased profits
 * increased market share

**Fixed Costs**
By increasing a firms total fixed costs, a firm can eliminate or lessen competition. Fixed costs are the costs a firm has to pay in order to operate, regardless of whether the firm is producing outputs or not.

Example A:¹
Firm A has a monopolist profit of $100 and Firm B wants to enter the market segement. Attempting to make entry easier, Firm B petitions the government to require a license (fixed cost) to produce in the market. The license will cost $50, and the outcome will determine if Firm B enters the market. Firm A has a choice to make (whether to buy the license), as does Firm B, whether or not to enter the market. If Firm A does not buy the license and Firm B does not enter, the profits will be ($100, $0), But if the Firm B does enter they will each make ($30, $30). Now if Firm A decides to purchase the license and Firm B decides not to entry the market then profits earned will be ($50, $0), but if Firm B does decides to enter the market the profits made will be ($-20, $-20). In this illustration, Firm A should purchase a license, because it will earn $50 verses not buying a license and having Firm B enter the market where both firms make only $30. By raising the ravils' costs, Firm B lowered the profit margins of Firm A but did not provide more competition because ultimately the license (fixed cost) did not create a win situation for firm B.

Example B:
Two taxi companies are fighting over the streets of Muncie Indiana--Taxi U and Taxi P. Taxi U petitions the local government to increase the registration costs of all taxi business $30. Before this time TU and TP had profits of ($45, $25). The city decides the extra revenue would be a good thing so they raise the fees (the raise is a manditory change). After the fees take effect TU and TP make a profit of ( $15, $-5). Since TP is now making a negative profit they move their taxi business to Fort Wayne were there are not any fees for Taxi Businees while TU profits decrease only $5 to $40 after the $30 fee because there is no competition in the city to fight for market share.

For more information regarding concepts in this section visit: Production Processes, and Costs Profit - the difference between economic and accounting costs, economic profit, economic losses, and zero economic profit Total cost including implicit and explicit costs.

**Vertical Integration**
In order to understand the effects a vertially integrated firm has on raising rivals' costs we need to understand what a vertically integrated firm does. This type of firm produces materials in both the output and input markets of production. By controlling material flow in the input or output levels firms can increase the prices of competitors in the other direction. For example, a firm with more control in the input flow can affect a firm in the output flow and vice versa. There are two ways to implement a verical integration strategy;
 * vertical foreclosure
 * price-cost squeeze

Vertical Foreclosure
This occurs when a company forces rivals in the chain of supply to go out of business by refusing to sell them products they need. This forces the rivals to shop elsewhere, and consequently to spend more money on a substitute. "A vertically integrated firm charges downstream rivals a prohibitive price for an essential input, thus forcing rivals to use more costly subsitutes or go out of business."¹ In the costs of production, materials increase ultimately as do production costs, which could drive the company out of the market.

It is important to recognize that vertical foreclosure is not always a profitable or more profitable decision. Logically, if you refuse to sell a product to your competitors down stream from you, you are going to lose market share (short-run). That is the point, to eliminate the competition below you. Now they have to find a new, potientially more expensive supplier, or go out of business. Once the competition is gone, vertical foreclosure is only profitable if the increase of sales from less competition compensate for the loss of ssles during the period of refusal to sell the product to select purchasers.

Price-cost Squeeze
This is a "tactic used by a vertically integrated firm to squeeze the margins of its competitors."¹ This is accomplished when a firm raises the costs of inputs while lowering (or maintaining) the cost of the final product being produced. By raising the costs of inputs, but not the final product, competitors beneath (down stream) them are unable to maintain the profit margins once experienced. The final cost is the same but the component part price to produce the same product is more expensive. This deteriorates the profit margins of any down stream competitors of the company that raised the input price.

There is another aspect of this strategy that is supported by the game theory understanding between companies, known as reputation. Price-cost squeezing can be used to punish a down stream rival for not colluding or joining in on market-sharing downstream. If a firm does decide to price-cost squeeze to punish rivals downsteam, they will take a hit on the short-term profits, but can generate higher long-term profits from such a decision.

Questions
1) Which of the following are methods of raising rivals' costs: I) Increase their Marginal Costs II) Affect their Fixed Costs III) Develop more horizontal information within the firm

2) True or False: Vertical Foreclosure may not be a highly profitable decision.

3) Which of the follwing is an implementatioan of vertical integration: a) Price-cost squeeze b) Vertical rent-seeking c) Horizontal foreclosure

4) What is the purpose of using a Price-cost squeeze strategy?

5) Why is vertical foreclosure not always a profitable strategy?

6) Which of the following is an example of a fixed cost increase? a) Increasing workforce to maintain production forecasts b) Raising a per peice tax on products c) Requiring a license to operate in a market that never had one before d) all of the above

Answers
1) I and II 2) True. This is a risky strategy in that it can leave a gap in suppliers, and cause short run loss in market share. 3) a 4) To squeeze the profit margins of the producers down stream in the vertically intagrated firm. Ultimately, decreasing the profits of firms down stream from the company implementing the strategy. 5) When you pick and choose who you are going to sell your products to you will lose business. You will not sell as much product of you did not choose to whom you are going to sell. 6) C - By requiring a license to operate in a market that never needed a license. This raises the fixed costs because if you want to produce you have to have a license (FC), even if you are not always producing products (VC).