This Case Study provides a high-level overview of the workflow without detailed explanation. It assumes you are already somewhat familiar with KNIME and Market Simulation. If not, start by reviewing the Building Blocks and Community Nodes.

Barriers to entry can come from patents, regulations, product differentiation, brand equity, and network effects. But the strategic decisions of the incumbents can also raise barriers to entry.

In the 1970s, Kmart and other “big box” retailers adopted new automated distribution and procurement controls with large fixed costs. These strategies reduced costs and prices, but had a modest impact on profitability. However, these high fixed costs raised barriers which prevented easy entry by new competitors.

Customer shopping baskets vary not only in size and price, but also in the cost to the retailer and the Consumer Surplus value provided to the customer. In this Market Simulation, it is assumed that customers could buy the same basket of goods at either Kmart or at the New Entrant’s store (once the New Entrant were to enter the market).

But the shopping experience of customers will vary by store. The experience offered by Kmart will be different than the experience offered by the New Entrant. And the experience will also vary by customer. Some customers will have a positive experience, but most customers will have a negative experience (after accounting for wasted time, distance traveled, parking, manual hauling, etc).

These individual values can be replicated by the consumer-agents in the Market Simulation.

Part-Worth

Each of the 10,000 customer-agents (C00001 to C10000) have individual values for Basket Price, Profit Margin, Consumer Surplus, and Store Experience.

Kmart pre-1970’s had no high fixed-cost automated distribution and procurement controls.

In this branch of the Market Simulation, customers select different baskets of goods to buy from Kmart. The simulation calculates the Cost, Profit Margin, Willingness To Pay (WTP), and Consumer Surplus of each basket (taking into account the positive or negative experience a customer would enjoy shopping at Kmart). The simulation then predicts the number of customers who actual purchase from Kmart, along with Kmart’s Revenue, COGS, and Profit.

Calculations include:

• Kmart Cost of Basket = Market Price / (1 + Margin %)
• Kmart Profit Margin = Market Price – Kmart Cost
• Kmart WTP = Market Price * (1 + Surplus %) + Kmart Experience
• Kmart Consumer Surplus = Kmart WTP – Market Price

Sum Sales

The GroupBy node counts the number of Customers, then calculates Kmart’s Revenue (sum of price paid), Cost of Goods Sold (sum of basket cost), and Profit (sum of margin).

Stage 2 of the Market Simulation considers the early arrival of a New Entrant. This predicts what would have happened in the 1970’s if a competitor had entered the market before Kmart had a chance to raise the barriers to entry by making large fixed cost investments.

Totals

In Stage 2, only Customer Experience differentiates Kmart from the New Entrant. Hence both vendors are expected to split the market evenly.

In Stage 3, Kmart makes the high-fixed-cost investment but no New Entrant arrives.

The simulation assumes that Kmart make a large, Fixed Cost investment that reduces both their Marginal Costs and Prices by 10%. That Fixed Cost is amortized so that end-of-period Profit must be reduced by 20,000. But this shift in business model doesn’t make a huge impact to the overall Profitability – even if a new competitor doesn’t enter the market.

In Stage 4, Kmart must compete against the New Entrant. But now we see that Kmart’s high-fixed-cost investment creates a Barrier to Entry for new Competitors.

This branch predicts what would happen if a new Competitor were to enter the Market using the old business model and without making the same level of investment as Kmart has made.

Here, customers compare the same Basket of Products – with Kmart Prices being 10% cheaper. Some Customers will still prefer the new Entrant Experience. But Kmart’s Market Share is not significantly weakened after the arrival of the New Entrant. On the other hand, the new Market Entrant has a much harder time generating sales. In this simulation, the Barrier to Entry created by Kmart ensure they’re twice as profitable as the Late New Entrant ($21,742 vs $10,059).

Kmart’s high-fixed-cost investment initially made little difference to it’s profitability. But its change in business model created a Barrier to Entry that makes it harder for new competitors to enter the market. Hence this Market Simulation has demonstrated Michael Porter’s proposition that the strategic decisions of the incumbents can also raise barriers to entry.

After Investment

Kmart’s investment created a Barrier to Entry. Now if a Late Market Entrant were to enter the market, Kmart could protect its profits.