Our (Time Warner’s) only competitor is District X currently provides bundled services

Question

Our (Time Warner’s) only competitor is District X currently provides bundled services

at $84.95. We are currently charging a 10% premium over their price, but there are unsubstantiated rumors that they are contemplating a 10% price increase. We don’t know their cost structure, so we don’t know whether their potential price increase is driven by cost increases or is merely a strategic move on their part.

Historically, when we both charge the same price, our market share is about 65%. When we charge a 10 percent premium over their price, our market share declines to about 60%. It appears that in those instances where they have charged a 10% premium over our price, our market share is about 70%. Please provide a recommendation regarding whether we should maintain our current price or reduce our price to $84.95.

Please factor into your recommendation that we pay programming fees to providers that amount to $32.50 for each subscriber. In addition, maintenance, service and billing costs are about $7.60 per subscriber. At present, there are about 110,000 households in the relevant area.

Questions:

1. Draw the payoff matrix (note that Time Warner and District x are the only ones in the market.

2. Based on the payoff matrix what recommendation would you give regarding whether Time Warner should maintain its current price or reduce it to $84.95? Explain your answer.

Economics