Unit five market structure and competition

LEAD-IN

Read the text and answer the questions that follow.

The notion of COMPETITION is widely used in economics in general and in microeconomics in particular. According to orthodox economic theory, competition is defined as a market situation in which suppliers strive for consumers in a way that induces a better allocation of resources and spurs efficiency.

Competition is considered the basis for capitalist or free market economies. Competition occurs when two or more organisations act independently to supply their products to the same group of consumers. Direct competition involves firms whose products are an approximate substitute for one another. Indirect competition occurs where the products are essentially different but still competing for the same pounds of consumer expenditure for example, gas versus heating oil or air versus rail travel.

The main challenge for business strategy is to find a way of achieving and keeping a sustainable competitive advantage over the other competing products and firms in a market.

A competitive advantage is an advantage over competitors gained by offering consumers greater value, either by means of lower prices or by providing greater benefits and service that justifies higher prices.

There are two bases on which firms can compete:

price – where firms are selling identical or very similar products, they must compete on price with each firm trying to undercut the others. Successful price competition depends on cost leadership, i.e. the ability to supply the product at a lower cost than any other competitor. A price cut by one firm can set off a price war, especially in tough economic times, when price becomes a much larger factor in purchasing decisions. Price wars usually occur when a business believes that price-cutting produces increased market share, but does not have a true cost advantage. When firms have similar cost structures, cutting prices means cutting profit margins. If a competitor undercuts a firm's prices, the firm's most natural response is to match the new low prices. However, this may prompt the competitor to cut prices again, leading to a worse situation. In the short term, price wars are good for buyers, who can take advantage of lower prices. Often they are not good for the companies involved because the lower prices reduce profit margins and can threaten their survival. In the medium to long term, price wars can be good for the dominant firms in the industry. Typically, the smaller firms cannot compete and have to close. The remaining firms absorb the market share of those that have closed. In the long term, the consumer may lose too. With fewer firms in the industry, prices tend to increase, sometimes higher than before the price war started.

• differentiation - non-price competition depends on making a product different from those of competitors and by giving it distinctive qualities that are valued by the target market. These might include branding, styling, special features or higher levels of customer service. Such factors can allow a premium price to be charged while still offering target customers competitive value-for-money.

In practice, many firms compete on a mix of price and differentiation, aiming to attract customers with a superior overall proposition.

Economists have identified four types of competition – perfect competition, monopolistic competition, oligopoly, and monopoly.

Perfect competition is a theoretical market structure in which competition is at its greatest possible level. Some markets, such as stock exchanges and commodity markets, approximate perfect competition. But a true state of perfect competition in a market is not attainable in real life. As a concept, though, perfect competition is useful because it functions as a standard to measure the efficiency and effectiveness of real world markets.

A perfectly competitive market contains these 5 elements:

• all firms sell identical products;

• all firms are price takers  they cannot control the market price of their product because price is determined by supply and demand;

• all firms have a relatively small market share; there are no monopolies;

• buyers have complete information about the product being sold and the prices charged by each firm;

• the industry is characterized by low barriers or no barriers to enter and exit an industry.

If any of these conditions are absent, it is an imperfect competition. Imperfect competition appears in several different forms.

Monopolistic competition exists when many sellers offer products to many buyers. Now, however, they do not sell identical products. Instead, they sell differentiated products  products that differ somewhat, or are perceived to differ, even though they serve a similar purpose. Products can be differentiated in a number of ways, including quality, style, convenience, location, and brand name. However, they are close substitutes of each other. Under monopolistic competition companies have only limited control over price.

The term monopoly has been derived from a Greek word Monopolian, which signifies a single seller. Monopoly refers to a market structure in which there is a single producer or seller that has a control on the entire market. This single seller deals in the products that have no close substitutes. Entry into such a market is restricted due to high costs or other impediments, which may be economic, social or political. A monopoly is characterized by the absence of competition, which can lead to high prices and inferior products and services. Governments attempt to prevent monopolies through the use of antitrust laws. The antitrust acts address such topics as price discrimination, price fixing and other unfair business practices. The laws are intended to preserve competition and allow smaller companies to enter a market, and not to simply suppress strong companies.

In an oligopoly, there are only a few firms that make up an industry. This select group of firms has control over the price and, like a monopoly, an oligopoly has high barriers to entry. The products that the oligopolistic firms produce are often nearly identical and, therefore, the companies, which are competing for market share, are interdependent as a result of market forces.

A market in which there are only a few large buyers for a product or service is called oligopsony. This allows the buyers to exert a great deal of control over the sellers and can effectively drive down prices. A good example of an oligopsony would be the U.S. fast food industry, in which a small number of large buyers (i.e. McDonald's, Burger King, Wendy's) controls the U.S. meat market. Such control allows these fast food mega-chains to dictate the price they pay to farmers for meat and to influence animal welfare conditions and labor standards. Monopsony (from the Greek mono ‘only’ and psonios ‘to buy’) is a situation which appears when a market exists for only a single consumer. The consumer has a special control over the price of products and the producers have to adapt themselves in some way to the demands of the buyer in matters of price and quantity.

On the basis of market position, market share, brand image, resources capacities, and domination power (degree of control over others), there are broadly four types of competitors, such as:

• market leaders

• market challengers

• market followers

• market nichers.

A market leader is a brand, product, or firm that has the largest percentage of total sales revenue of a market (the biggest market share) that dominates its competitors in customer loyalty, distribution coverage, image, perceived value, price, profit, and promotional spending. To remain dominant, the leader looks for ways to expand total market demand, attempts to protect its current market share, and perhaps tries to increase its market share.

A market challenger attacks the market leader and other competitors in an aggressive bid for more market share. Market challengers are able to jockey for industry leadership in several ways: challenging the market leader on price (direct approach), increasing product differentiation or improving customer service (indirect approach), or launching an entirely new product or service in order to change the field (radical approach).

A market follower is a runner-up firm that is willing to maintain its market share and not rock the boat. A follower starts with a much smaller market share but can benefit from the marketing efforts aimed at consumer education expended by the front-running firm. A follower can play the role of counterfeiter, cloner, imitator, or adapter.

A market nicher serves small market segments not being served by larger firms. The key to nichemanship is specialization. Nichers develop offerings to fully meet a certain group of customers’ needs, commanding a premium price in the process.

Competition is of great importance to the functioning of market economies. It enhances allocative efficiency by securing that supply conforms to consumer preferences and resources are directed to their most valued use. It enhances productive efficiency by minimizing production costs and sets incentives for the development of new products and production techniques. Healthy competition is good, but overly aggressive price wars can have negative long-term effects for both consumers and firms. There will always be a place for a low-cost leader, but other firms can respond to price challenges more intelligently by differentiating their products and delivering a superior offering to consumers.

Based on www.investopedia.com

Answer the questions.

1. How is competition defined by economists? Why is it considered to be the basis for free market economy?

2. What is direct/indirect competition?

3. What impact does competition have on a) businesses b) consumers c) economy?

4. What are the sources of sustainable competitive advantage a business can exploit?

5. How can companies cope with the pressure created by reduced prices?

6. What is a price war? Are there any winners or losers?

7. What are the non-price competition methods and tools?

8. Which is the most/least competitive market structure?

9. In which form of market structure is price the main factor for success in competition?

10. In which market structure do producers have the most market power?

11. What is a price-taker?

12. What is the difference between oligopoly and oligopsony?

13. What does it take to become a market leader?

14. What market players can be called a market challenger and a market follower?

15. What are the firms that make products and/or services for specific demand of customers which are not met by otherwise available products?