Defining Oligopoly and Game Theory

The main ideas of the game theory are:

·         They exist in oligopoly type of market

·         There is a mutual interdependence between firms

·         Each firm is analyzing the behavior of rivals

·         The firm can act in collusion and non-collusion

“Game theory was developed by economists John Neumann and Oskar Morgenstern in the 1940s to analyze strategic behavior” (Principles of Microeconomics, John E. Sayre, Alan J. Morris). The theory, I assume, was the result of observation on a human nature.

There are numerous evidences of game theory in the current economy. One of the examples was presented in a textbook – OPEC. As a cartel organization, OPEC raised the oil prices acting collusively.

The payoff matrix shows possible scenarios of market/profit share for collusive agreements. The main idea of the matrix is to show the options based on firms’ sticking/non-sticking to the agreement.

The main principle of collusive/cartel idea is to come to an agreement on prices, market share or production quotas. In this way, all participants will gain the maximum profit share. The main condition for gaining this maximum profit share is no cheating among the participants. This main condition can be maintained only during relatively short period of time. History shows that all firms tend to cheat trying to gain extra profit or market share.

Defining Monopolistic Competition

Monopolistic Competition will form a market where all small companies will make a zero economic profits in a long-run. It happens because of easy entry of new players. Many sellers are on the market, and they strive to produce differentiated products. Differentiation is achieved by physical differences, perceived differences or support services.

References:

http://www.cobsbread.com/home/

http://www.carecentre.ca/website/DesktopDefault.aspx?tabindex=0&tabid=195

http://www.chevron.ca/operations/refining/refineryworks.asp

Competing as Starbucks

Starbucks can be considered as a part of a perfect competition market because it fits all four major conditions (by textbook “Microeconomics”, John E. Sayre, Alan J. Morris)):

·         The industry is represented by many small buyers and sellers all of whom are price-takers

·         No preferences shown

·         Easy entry and exit by both buyers and sellers

·         The same market information available to all

The main reason for re-aligning Starbucks business practices was the fact that many stores became unprofitable. They became unprofitable because Starbucks was “blended in” with many small and cheap coffee stores. The idea of “special, homemade” coffee was lost and it “has led to competitors of all kinds, small and large coffee companies, fast food operators, and mom and pops” to take their niche (http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html).

Starbucks was trying to gain back the special customers’ attitude by moving their business into another, more expensive area. Going back to the conditions perfect competition, Starbucks was trying to get “out of the box” of perfect competition.

I assume the strategy was:

·         Let the customers show their preferences for their product

·         Use their unique expertize for little coffee shop atmosphere

Therefore, they closed the number of stores. It was impossible to get to upper standards of operating the business with existing fast-food practices, which came into play with greater quantity of stores.

“In total, the company forecast up to $348 million US in charges related to the closures, with $200 million to be booked in the fiscal third quarter ended June 30” (http://www.cbc.ca/news/business/story/2008/07/01/starbucks-closures.html).

Those charged are short-run. I think company will gain in a long-run by raising prices for coffee and providing unique service to the customers.

“Starbucks Corp. recently announced that it would be expanding its coffee offerings as well as offering a new line of pies and tarts. Additionally, the coffee giant will also begin selling a single serve coffee maker this year.

Moving forward, mounting commodity costs and greater competition will likely be headwinds for specialty eateries for the remainder of the year. However, successful new product lines and ad campaigns in combination with the recovering economy could lead to gains in both the short- and long-term” (http://www.marketwatch.com/story/analytical-reports-on-starbucks-corp-and-panera-bread-company-eateries-respond-to-greater-competition-2012-03-14?reflink=MW_news_stmp).

I personally think the prices in Starbucks are too high but many customers don’t think so. What Starbucks sales most likely are emotions and special experience with coffee.

On the top of it Starbucks provides the highest quality coffee to its customers.

“Years of focus and expertise have led to the Starbucks Roast Spectrum. Each coffee bean requires a unique balance of temperature and time to reach its individual peak of aroma, acidity, body and flavor. Our coffees are classified by three roast profiles – Starbucks® Blonde Roast, Medium Roast and Dark Roast – so you can easily find the flavor and intensity that’s perfect for you”( http://www.starbucks.com/coffee/learn/roast).

If Starbucks lower the prices they would experience immediate demand increase for their product as they would attract customers from their competitors. At the same time, they wouldn’t be able to provide the same level of service and their profits will get back to the same level (or lower) as there would be no differentiation between Starbuck and their competitors.

References:

http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html

http://www.cbc.ca/news/business/story/2008/07/01/starbucks-closures.html

http://www.marketwatch.com/story/analytical-reports-on-starbucks-corp-and-panera-bread-company-eateries-respond-to-greater-competition-2012-03-14?reflink=MW_news_stmp

http://www.starbucks.com/coffee/learn/roast

http://seattletimes.nwsource.com/html/businesstechnology/2008028854_starbucks02.html

Long Run Costs and Economies of Scale

I would create a Spa Salon. It would be the best to start with a small business and as it grows turn it into a medium business by suggesting more services.

The following services could be offered from the very beginning:

·         Hair styling

·         Massages

·         Manicure and pedicure

·         Facials and skin treatment

·         Body treatments

·         Make up application

Two or three specialist will be required to offer the above range of services. Some spa salons operate with only couple employees but I think that specialization will increase professionalism and customer satisfaction.

When business becomes profitable it will be possible to offer more services like day spas, and operated with hotels several days spa programs. We can also suggest such services as weight loss and health supplements. The perfect size of business for this industry is medium – 10-12 employees (may be it is considered small). Smaller business is able to maintain closer relationships with its customers and provide more emotional satisfaction, which is critical for this type of business.

Spa salons usually target the local market. Demographically: young men between 17 and 28; and women between 15 and 55. Ideally Spa salon should be located in downtown to offer services to busy professionals.

Some costs the business will face are:

Long run costs: equipment and instruments, technology.

Short-run costs: working materials like creams, lotions, make up.

Fixed costs: rent, salaries, certificates, taxes.

The following article gives some idea to possible strengths and weaknesses of the business.

http://startingaspabusiness.com/

Strengths:

·         relatively small cost of starting the business

·         entry to industry is easy

·         high demand for services

·         industry is developing rapidly with new technology and new products

Weaknesses:

This business is highly dependent on quality of services provided. The article uses the term “happiness factor” which means complete and full customer satisfaction. The “word of mouth” sometimes means more than well done advertising program. People employed in the business will be the main factor of success. The best way to solve this problem is to create and maintain close relationships with highly trained professionals in the industry and offer them competitive salaries and working conditions in your business.