When a rival firm cuts its price, the best strategic response of the firm, in many cases, is to retaliate with a price cut of its own. However, successive repetitions of price cutting, often referred to as “price wars,” can result in all firms doing worse than if they had not entered a price war. If managers can find a way to cooperate in setting their prices, they can avoid getting into a low-price, low-profit situation and, instead, reach a higher-price, higher-profit situation. As the forces of globalization and deregulation of markets have made markets more diverse and competitive, price wars have become more common. Indeed, price wars are so common now that most managers will face a price war some time in their careers.
Price wars leave oligopoly firms in situations like the non-cooperative Nash equilibrium cell in the prisoners’ dilemmas as we have discussed in this term. Price wars can be avoided, just as the non-cooperative Nash cell can be avoided, if firms can find ways to cooperate. Explicit arrangements to coordinate prices, frequently called “collusion” and “price-fixing,” are illegal in the United States; and, many other nations, especially in Europe, are outlawing price-fixing. Tacit collusion (i.e., agreement without explicit communication) is also illegal, but is more difficult to discover and prove. Penalties for price-fixing in the United States can be quite severe. In addition to facing steep fines and public scorns, business executives can and do go to prison for the crime of price fixing.
So, there is the problem of price wars: Retaliatory price-cutting can lead to costly price wars, but attempts at setting prices cooperatively are generally illegal. You have been asked to help resolve this difficult issue so that business executives will not risk landing them in jail.
What practical advices or tactics would you provide to business executives as to what they can do that won’t land them in jail for attempted price-fixing and to avoid being drawn into price wars?