Texas FIN 372 – Differentiation as Defense

Texas FIN 372 – Differentiation as Defense

Subject: General Questions    / General General Questions

Question
Solving the second part of this problem set: “Differentiation as Defense”, parts A-C.

Problem Set #, You are allowed to work in groups, but each student must write up his or her work independently;
please note on your answer sheet with whom you worked. Be sure to provide the reasoning behind
your answer in order to receive full credit. Deciding on Capacity You are a division manager for Wayne Biotech, and are tasked with deciding on the capacity of your
new factory for a new ecologically friendly weed killer. A similar new product has been developed by
Isley Industries. The demand for the new weed killer is given = 48 ? 2, where is the price, = ! + ! , and ! and ! are the quantity produced by Wayne and Isley, respectively. Wayne’s
cost of production per unit is 4; Isley’s cost of production per unit is 2.
a) Wayne and Isley will simultaneously decide on the capacity of their production facility, i.e.,
each will simultaneously decide on quantity. What quantity will you produce? What quantity
do you expect Isley to produce? What are your expected profits? (20 points)
b) You have the ability to accelerate the building of your production facility, but doing so will
increase the total cost of the facility by 7. If you do so, Isley will observe your capacity
before choosing the capacity of their plant. What quantity will you choose if you accelerate
the building of your plant? Is accelerating the building of your production facility
worthwhile? Why or why not? (20 points) Differentiation as Defense Hastur Hospitality offers a quaint bed-and-breakfast (B&B) experience in the coastal city of
Innsmouth in northeast Massachusetts. Demand comes both from travelers visiting the town of
Innsmouth as well as travelers visiting the nearby town of Dunwich. Demand for staying in
Innsmouth is given by ! = 24 ? ! , where ! is the price that Hastur charges for staying at its
B&B in Innsmouth. There is additional demand from Dunwich, and is given by ! = 20 ? ! , so
long as no B&B is present in Dunwich, which is currently the case. Hastur’s marginal cost of service
is 8.
a) Your goal as the manager in charge of pricing is to maximize profit. What price will you set
at your Innsmouth location? What is your expected profit? (15 points)
A desirable piece of real estate in Dunwich has recently gone on sale; Hastur now has the chance to
build a B&B in Dunwich as well, at a fixed cost of 40. Vacationers in Dunwich generate a demand
for a B&B in Dunwich of ! = 24 ? ! , where ! is the price charged at the Dunwich location; of course, building a B&B in Dunwich will completely eliminate demand from Dunwich for the
Innsmouth facility. (The marginal cost of production for Hastur will be 8 at this site as well.)
b) What pricing strategy will you use if you decide to expand, i.e., build a Dunwich facility? Is it
profitable to build such a facility? Why or why not? (20 points)
You now learn that your competitor, Nyarlathotep Accomodations (“Live like a pharaoh!”) is also
contemplating buying the property in Dunwich; if you pass on the opportunity, Nyarlathotep will
then have a chance to enter (at the same fixed cost of 40) the Dunwich market. Nyarlathotep’s cost
of entry is the same as yours, 40, and his marginal cost of production is also 8. If Nyarlathotep
enters, you will first set your price, and then he will set his. Note that the B&B in Dunwich will not
take customers from the B&B in Innsmouth, nor will the B&B in Innsmouth take customers from
the B&B in Dunwich.
c) If Nyarlathotep enters, what will your pricing strategy be? What do you expect his pricing
strategy to be? Will you now choose to enter the Dunwich market yourself? Why or why
not? (25 points)