(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 526

CHAPTER 13 • Game Theory and Competitive Strategy 501 EX AMPLE 13 OLIGOPOLISTIC COOPERATION IN THE WATER METER INDUSTRY For some four decades, almost all the water meters sold in the United States have been produced by four American companies: Rockwell International, Badger Meter, Neptune Water Meter Company, and Hersey Products.10 Most buyers of water meters are municipal water utilities, who install the meters in residential and commercial establishments in order to measure water consumption and bill consumers accordingly Because the cost of meters is a small part of the total cost of providing water, utilities are concerned mainly that the meters be accurate and reliable Price is not a primary issue, and demand is very inelastic Demand is also very stable; because every residence or business must have a water meter, demand grows slowly along with the population In addition, utilities tend to have long-standing relationships with suppliers and are reluctant to shift from one to another Because any new entrant will find it difficult to lure customers from existing firms, this creates a barrier to entry Substantial economies of scale create a second barrier to entry: To capture a significant share of the market, a new entrant must invest in a large factory This requirement virtually precludes entry by new firms With inelastic and stable demand and little threat of entry by new firms, the existing four firms could earn substantial monopoly profits if they set prices cooperatively If, on the other hand, they compete aggressively, with each firm cutting price to increase its own share of the market, profits would fall to nearly competitive levels The firms thus face a prisoners’ dilemma Can cooperation prevail? It can and has prevailed Remember that the same four firms have been playing a repeated game for decades Demand has been stable and predictable, and over the years, the firms have been able to assess their own and each other’s costs In this situation, titfor-tat strategies work well: It pays each firm to cooperate as long as its competitors are cooperating As a result, the four firms operate as though they were members of a country club There is rarely an attempt to undercut price, and each firm appears satisfied with its share of the market While the business may appear dull, it is certainly profitable All four firms have been earning returns on their investments that far exceed those in more competitive industries EX AMPLE 13 COMPETITION AND COLLUSION IN THE AIRLINE INDUSTRY In March 1983, American Airlines proposed that all airlines adopt a uniform fare schedule based on mileage The rate per mile would depend on the length of the trip, with the lowest rate of 15 cents per mile for trips over 10 2500 miles, higher rates for shorter trips, and the highest rate, 53 cents per mile, for trips under 250 miles For example, a one-way coach ticket from Boston to Chicago, a distance of 932 miles, would cost This example is based in part on Nancy Taubenslag, “Rockwell International,” Harvard Business School Case No 9-383-019, July 1983 In the late 1980s, Rockwell split up and sold its water meter division to British Tyre & Rubber, which later became part of Invensys, a multinational company that markets water meters in the United States under the Foxboro brand Hersey became a subsidiary of Mueller Products in 1999, but still sells meters under the Hersey name Badger and Neptune continue to operate as stand-alone companies