So hello back. We're still looking at strategies for firms that intend to enter a new industry. We've previously looked at commitment and value chain reconfiguration in the previous video. We're now going to move on to Judo economics and niche markets as two alternative strategies that have fairly similar mechanics, that have a fairly similar intuition behind them, but they also differ in important ways. So what does Judo economics mean in the first place? So why Judo economics? The art of Judo is basically about taking the strength of your rival and using it to your advantage. And Judo economics is trying to do something very similar in the context of an entrant who is small and an incumbent, who is large. So let's see how this works. An entrant enters into a market and he sets a price that's lower than the incumbent's price. So it's pL, the entrant's price, the incumbent's price is pH. That may seem very aggressive. However, while charging a lower price, the entrant also limits capacity to serve just a small portion of the overall market. So, the portion of the entrant, the capacity of the entrant is xE and that's a fraction of the overall size of the market which is x. It also signals to the incumbent that in the future it's not going to increase capacity drastically. So, apart from the fact that they charge a lower price, which may seem aggressive, the fact that they choose to go for a lower market share, seems fairly unaggressive, seems fairly soft to a potential entrant. So what does an incumbent do? How does an incumbent react to this behavior? Well, an incumbent obviously will realize that his profits will go down. Because after all, there's an entrant coming in and he comes in at a lower price, with a lower price of pL. So he's going to lose some market share to the entrant. And that market share is xE. This is the capacity of the entrant. So one option would be to fight back and try to drive the entrant out of the market. He can do so by charging a price that's marginally lower than the entrance price. In that case, he will incur losses through this price reduction. So the margin goes down from pH to pL. Okay, so the difference between that is the loss in margin. So, when do we want to fight, when do we want to accommodate? What's the intuition? The incumbent here does not attack, he does not retaliate if the losses from accepting the entrant are less than the losses from attacking the entrant. Let's have a closer look at these two expressions. So pH times xE. That's what the incumbent loses because the entrant charges a lower price for a capacity of xE. So he loses xE on which he would otherwise have made pH. That was the high price that he was charging before. On the other hand, we have the loss from attacking the entrant. That's what happens if he lowers the price from pH to pL. And he continues to serve the entire market, which is x. So when does incumbent accommodate, when does he retaliate? That depends on a number of factors in these two equations. So the first one is the market size of the incumbent. That's our x here. If x is large, if the market size or the market of the incumbent is large, then he's going to be less likely to retaliate, because it would be costly, right? Lowering profit margin for everyone that he would otherwise sell to, is going to be an expensive business. So large x means less likely to deter, to retaliate. The market share of the entrant, or the capacity of the entrant, that's xE. The smaller xE, the less likely it is that the incumbent is going to fight back. Because he feels less threatened by a small capacity. And finally we can look at the price difference between pH and pL. So if pL is much smaller, so if the price difference is much smaller between pH and pL, that's going to make it less attractive for the incumbent to retaliate. Why? Because he would suffer quite a bit from lowering the margin. Not just for the ones that would otherwise buy from the entrant, but also for everyone else in the market. So, for all of x. So these three factors influence the success of the entrant from playing the Judo Economics strategy. Market size of the incumbent, capacity of the entrant and the price difference between the high price of the incumbent and the low price of the entrant. Can we have an example of this? When did this actually happen? Well, here's one. Where Amazon entered the market for online book retailing versus Barnes and Noble which was the largest off-line brick and mortar retailer. Amazon entered the online book retail market in 1994. At the time, Barnes & Noble, which was the leading US book retailer, of course, have the option of also starting its own online store, but they didn't. And why did they not do that? Well, their fear, which was a very realistic fear I think, their fear was that opening an online store would trigger an online price war between Amazon and Barnes & Noble, and they would eventually cannibalize sales through classical bookstores, right? Because as prices online go lower and lower, it's going to mean that online bookstores become more competitive vis a vis offline bookstores, so that would cannibalize them. Course, as it turned out, Amazon started taking consumers away from classical bookstores anyway. Why did they do this? How did they do this? Well, increasingly the online market started growing and Barnes & Noble and other retailers, other book retailers, started losing market share to online retailer. So a second strategy is committing to a niche market. To staying in a niche market. The entrant here, focuses on a niche market, which makes it infeasible for the incumbent to retaliate across the board, very much like the example that we've seen in Judo economics. Let me give you two examples of this, and of those one was successful, the other one was unsuccessful. So one successful niche market strategy which was not met by retaliation was entry by a local phone operator called NetCologne, offering services just in Cologne. So it was clear that they would only offer services in one particular city in Germany. They would not want to expand. It was clearly, even by the name NetCologne, it was clear that they would always focus on this geographical market. Now, Deutsche Telekom at the time was the incumbent and they were thinking about retaliating or not. And it was clear that Deutsche Telekom was not able to reduce prices just for one particular city. Right? So this would have felt strange to say consumers in Dusseldorf which is a fairly close-by city, that was not a realistic strategy to do. So city-specific price reductions were not an option for Deutsche Telekom and therefore NetCologne was able to carve out a niche for themselves in Cologne. Looking at an unsuccessful niche market strategy which was basically retaliated by the incumbent was again our old example of Deutsche BA. Deutsche BA again also entered the German domestic flights market only on certain routes. So for example, if, Deutsche BA only enters the Munich-Dusseldorf route they might leave the route of Munich to Berlin open to Lufthansa. Now, the difference here was that Lufthansa could retaliate on particular routes so they only had to lower prices for Munich-Dusseldorf and could keep prices high for routes between Munich and Berlin. Now what that meant is that it was fairly cheap for Lufthansa to retaliate because they could focus retaliation only on that market niche. Whereas this was not the case for the example of NetCologne where Deutsche Telekom would have had to lower prices all through the board. So in the last two videos we've asked how firms can enter a new market. For the rest of the session, we're going to switch sides. And we're going to look at firms that are already active in their respective industry, the incumbents. They of course are not particularly happy about a new competitor coming in and they may try out strategies to keep potential entrants away from their market. So what they can do against entry will be the topic of the coming videos. So stay tuned for now, and I'll see you in a few minutes.
