If major UK Supermarkets 'price match' Lidl (a new entrant based on European supply chains) is this competitive or oligopolistic behaviour?

 

Oligopolies are interdependent. This means that they follow the actions of the small number of other large firms in their markets closely. Since an oligopolistic firm faces a kinked demand curve, its directors know that cutting prices will usually not result in a gain of customers greater than the loss of revenue. This is modelled in the oligopoly graph whereby the AR (demand) curve slopes slightly but inelastically downward after the ‘kink’ point at which customers cease to be concerned with price, leaving the MR line to tumble straight down.

The most rational, but usually illegal, way for oligopolies to avoid the danger that other firms choose to cut prices in a way that makes consumers price-conscious, and which thereby breaks both the kink and the level of profit enjoyed by firms, is to collude. If firms form a cartel and fix prices by agreement, consumers have no choice but to pay the price the cartel sets. Cartels depend on firms controlling supply and sticking to agreements, but in national and non-state markets, they can lead to fines for companies and jail terms for directors.

A more subtle way for firms to collude in oligopolistic markets is for one firm or trade body to be a ‘price leader’ and for others to then copy that firm to within a few percentage points. This does not generally awaken consumers to the collusion, and nor is it easy to prove on the part of regulators. However, it does depend on trust between firms, and can be broken if at least one firm decides to change its prices regardless of the leader or the group for temporary advantage.

In such circumstance, firms have developed a whole set of expensively funded ‘game theory’ responses to interdependence. These characterise existence within the market as a competition in which various scenarios, such as ‘win-win’, ‘win-lose’ or ‘lose-lose’ exist and can be modelled. These scenarios suggest that firms can watch each other, and decide to adopt a strategy of maintaining their own prices whilst others raise prices, matching lower prices to retain their own percentage of the market, or adopting the ‘least worse, second-best' nash equilibrium position to ensure that everyone still makes some money when one changes price. 

The options which bring firms to these outcomes are known as ‘dominant’ or ‘maximax’ (where firms maximise gain) minimax, where firms minimise their maximum loss (a strategy of security and safety) or collusive. They can be shown on ‘payoff matrices.’

Large firms such as the bigger supermarkets, in choosing their strategies, must be careful because if they are seen to be engaging in ‘predatory pricing’ they are acting illegally. Predatory pricing involves charging a price below that of another at a loss, in order to put the other out of business.

In the question, ‘price-matching’ might be neither collusive nor predatory. For instance, if the supermarkets involved are merely bringing down prices on some lines, but still making a profit overall, they are not being predatory. In fact, their reduction of price to meet those of a company which in the UK is an insurgent newcomer, like Lidl, would be an example of competition at work and good for the consumer and economy because it lowered prices and increased allocative and productive efficiency.

If the large supermarkets were matching higher Lidl prices, but the market were contestable so that others could enter if they wanted to, regulators might not intervene. This would be all the truer if the goods to which the policy applied were not seen as vital or necessities.

The large supermarkets might only seem to be exercising oligopoly control over price or supply in any event. It is possible that the former oligopoly in their products is descending into imperfect competition because of the entry of Lidl into the market. Imperfect competition is a dynamic process in which firms begin with an abnormal profit, because they are a sole local supplier or have low fixed costs and little competition. If the market had low barriers to entry, then over time the abnormal profit would be eroded because revenues would have to be shared with others and costs would rise. This would be especially true as advertising and marketing are fixed costs and rise when competition appears.

Supermarkets price-matching Lidl might therefore not be an example of oligopoly behaviour at all, so much as a response to a new firm entering the market and undermining oligopoly in favour of a freer market. The effect of such interventions is often that the monopoly of a brand or position which firms initially enjoy erodes, and a strategy of ‘stemming the rot’ by price matching on some brands is a rational response.

Another factor which should be considered, however, is that supermarkets, like many other firms which appear to be oligopolies, could also be oligopsonies to their suppliers. An oligopsony is a market in which there are a few large buyers rather than a few large sellers. Oligopsony status allows for supply chain power.

If Lidl was largely supplied by foreign firms, but the other UK supermarkets used British suppliers who found it difficult to export, or who were unable to easily switch to non-supermarket buyers, UK supermarkets could ‘price match’ Lidl but maintain profits. They could do this by ‘squeezing’ suppliers who had less power.

If the UK supermarkets did so in a concerted or collusive manner, they would pass on the pain of price-matching but realise the gain of keeping customers from comparing prices too closely, and thus becoming price-aware and breaking out of the ‘kinked’ mindset of habitual or indifferent purchasing. Lidl might even be persuaded not to press its advantage and to adopt a maximax strategy as a new price leader, allowing all supermarkets to raise prices in response to Lidl.

*Note: There is no evidence of any collusion or predatory pricing by UK supermarkets or Lidl in the real world known to the author and nor should the essay above be construed as anything other than theoretical speculation on the point.