Tuesday, April 3, 2012

Class #13 Highlights

In this class, we studied how to avoid price wars and, more generally, how to achieve tacit cooperation. The setting was the steam turbine business with competitors GE and Westinghouse. The industry structure was only moderately attractive. While there were few competitors and barriers to entry were high, at the same time the good was undifferentiated and there was excess capacity in the market.

A key feature of the business landscape was that negotiations were conducted in secret. This seems natural--secrecy is a standard tool for maintaining one's bargaining power in the face of tough and concentrated downstream buyers. But secrecy causes problems for maintaining price discipline.

GE solved the problem by recognizing the four keys to successful cooperation:
1. Transparency
2. Credibility and speed of punishment.
3. Proportionality
4. Forgiveness

The transparency problem was solved through a simplified price book, no negotiations from listed prices, publishing quotes and orders, and making all this information available via audit to any downstream party requesting it. The other aspects were solved through the use of a multiplier on listed prices, which could be quickly adjusted and then reset to turn on and off punishments.

On the one hand, this solution surrenders some bargaining power to buyers; however, by removing the latitude of its sales staff to negotiate deals, GE arguably reclaimed some of this bargaining power through commitment.

GE also did one other clever thing--they reduced their own temptation to cheat through price protection guarantees to buyers. These guarantees meant that future price reductions would be less profitable for GE and hence there would be less incentive to renege on the agreement.

Key Takeaways

  • Clarity, transparency, credibility, and forgiveness are all essential to successful coordination.
  • Reducing the profits from cheating also makes agreement easier
  • Achieving these objectives may require sacrificing bargaining power elsewhere.

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