Answer to Question #43110 in Management for Pragash Thiagarajan

Question

Why would smaller firms be content to let a large firm practice dominant firm price leadership in an industry?

Answer 1

Price leadership can leave the leader's rivals with little choice but to follow its lead and match these prices if they are to hold onto their market share. Alternatively, competitors may also choose to lower their prices in the hope of gaining market share as discounters.

Price leadership can be positive when the leader sets prices higher, since its competitors would be justified in ratcheting their prices higher as well, without the threat of losing market share. In fact, higher prices may improve profitability for all firms.

More commonly, undisputed market leaders such as the big-box retailers usetheir operating efficiencies to relentlessly mark down prices. This forces smaller rivals to lower prices as well in order to retain market share. Since these smaller firms often do not have the same economies of scale as the price leaders, this attempt to match the leader's prices may lead to mounting losses
over a prolonged period, to the point where they may be forced to eventually close their doors.