Hit and run competition occurs when a firm temporarily enters a market and then leaves when supernormal profits are exhausted. A key feature is low sunk costs.
A sunk cost is a cost that cannot be recovered when leaving, e.g. spending on advertising. HIgh sunk costs would make it hard for a firm to engage in hit and run competition
Hit and run competition is considered to be a feature of a contestable market. A contestable market has low barriers to entry and exit. Therefore, if firms in the industry are making supernormal profits, there is an incentive for a new firm to enter and take advantage of the high profits, but leave when the profitability of industry deteriorates.
If the industry no longer makes supernormal profits, it is easy for the firm to exit and leave without excessive costs.
The threat of hit and run competition may be sufficient to keep prices and profits low. If the market is perfectly contestable, firms might wish to engage in some form of limit pricing to avoid the disruption of hit and run competition.
Example of Hit and Run Competition
Clothing. If a type of clothing becomes particularly fashionable (for example the Onesie), firms can set high prices and make supernormal profits. However, this will encourage other firms to enter into the market and also produce Onesies. If it falls out of fashion, some clothing firms will leave that particular segment of the clothing market. Therefore, firms may enter the ‘Onesie’ market for just a short time – a classic example of hit and run competition.
Tourist Guide. Hit and run competition may also be highly seasonal. For example in the peak of summer, being a tourist guide becomes quite profitable. Therefore, some entrepreneurs may temporarily enter the market until supernormal profits are exhausted at the end of the tourist season.
Airline routes (short-haul) Suppose an existing airline is earning supernormal profits on a route (e.g. London–Paris). Another airline can lease aircraft, hire crew on short contracts, and start flying the route quickly. The entrant undercuts prices, increasing supply and forcing prices down. Once profits fall to normal (or losses appear), the entrant withdraws the service and reallocates planes elsewhere.
Mobile food vans. If a concert brings in more visitors to an area, a mobile food van can visit and benefit from temporary surge in demand, but then leave when profits are exhausted.
Requirements for Hit and Run Competition
- Good information about the profitability of the industry.
- Low barriers to entry and exit
- Low sunk costs. Sunk costs are unrecoverable and so will create a costly exit – discouraging hit and run competition.
- Recoverable costs. Capital that can easily be sold if the firm needs to leave.
Summary of hit and run competition
- Hit-and-run competition occurs in contestable markets.
- It requires low barriers to entry and exit, especially low sunk costs.
- Firms may earn supernormal profits only temporarily.
- Hit and run competition is good for consumers – helping to keep prices low, and increase supply during peak demand. However, in industries with high sunk costs it is not practical.
Related posts
About The Author
