mn 304 - market structure 1 - 4

7/27/2019 MN 304 - Market Structure 1 - 4

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Market Structure Analysis

Objectives of the Lecture

1)To give basic idea about Structure - Conduct - Performance (SCP)

Framework.

2) To give basic idea about Porters Five Forces Model/Analysis.

3) To give basic knowledge about Various Market Structures

a) Perfect Competitionb) Monopoly/Monopsony

c) Monopolistic Competition

e) Oilgopoly

4) To apply SCP framework to various market structures.5) To apply Porters Five Forces model to practical problems.


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The Structure Conduct Performance (SCP) Framework

Generally two approaches are used to characterize and to analyze

markets.

1) SCP approach2) Porters five forces analysis

The importance of analysis of market structure:

1) Structure affects for the conduct and it affects for the performance of

the firm.2) To formulate strategic policies (strategy).

SCP framework mainly developed by Mason and Bain and it is a neo-

classical tool which assumes that firms maximize profits, consumers

maximize utility and markets tend towards a position of equilibrium.

This framework is useful to classify and to analyze industries. It is

simple, easy to apply, easy to understand, not industry specific and

therefore can use on different industries and for comparative purposes.


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The Nature of SCP

Basic Conditions

Structure

Conduct

Performance


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SCP Framework : Industry Structure

the way in which the market is organised or theunderlying factors which determine the competitive

relations between sellers

The nature of product

Cost conditions

Demand conditions

Existence of economies of scales and scope

number and size distribution of firms/sellers(concentration)

Number and size distribution of the buyers Conditions of entry and exit

Product differentiation

Corporate integration

Diversification


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SCP Framework : IndustryConduct

the behaviour of firms as they interactwith each other and customers orfactors which are under control of firm

Pricing policies

Marketing and advertising strategies

Financing policies

The degree of competition or cooperation

Output decisions

R & D and innovation

Growth and merger behaviour


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SCP Framework : Industry Performance

the level of efficiency achieved by firms in their use ofscarce resources or indicators which measure theperformance of the organization

extent of profits - normal v. abnormal profits

allocative efficiency(Marginal social benefits =marginal social costs of production)

productive efficiency(Usage of resources moreefficiently than before)

net economic welfare - deadweight losses

Size and growth of industry output

the development of product and technology


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Criticisms and alternatives to SCP framework

1) Structure is determined exogenously in simple SCP

framework. S C P. Here no answer for thequestion of what shapes the structure.

2) Most of these factors are overlapping and interrelated

with respect to S, C and P.

3) Market or industry specific nature limit its application tomulti-products or diversified firms.

4) Most of the empirical studies are concerned only about

structure and performance. No place for conduct.

5) Actual market situation is not given a proper place in

determination of conduct and performance specially in

contestable markets (markets no barriers to entry or exist).

Alternative to this is the Porters five forces analysis.


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Measuring the Market ConcentrationMarket concentration refers to the extent to which the supply of a good

or service is controlled by the leading suppliers of the product

Commonly used measures : Concentration Ratio (market supplied by the given number of firms

1.8)

Market share (market share analyzes according to employment,

value added, output and capital) Profits rates (high profits in monopoly)

Lerner index (P-MC/P)

Herfindahl Index (HI) (measures the size distribution of the firm orlevel of market concentration. Index depends on the number offirms in the industry and their relative market share. Value closerto 1 says increased monopolization).

Lorenz curve (This shows relationship between cumulative % offirms in the industry and the cumulative % of market share)

Gini coefficient (measure of concentration in market)


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Porters Five Forces Analysis

This model also can be used to classify and analyze industries. Itcan be used to analyze the current market position and in

formulation of strategic policies. This use same factors as SCP but

characterize under different headings:

1) Current competition or the Extent of Competitive Rivalry

2) Potential competition or threat of Potential New Entrants

3) Threat of substitute products

4) The power of buyers5) The power of suppliers


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What are the key forces influencing anorganization?

Could these forces change:

Is there a case for changing strategicrelationship with suppliers?

Is there a case for forming a new relationshipwith large buyers?

Are there any technical developments that rivalscould use to dramatically alter the environment?

What can management do to influence theseforces?

Are some industries more attractive than others?

Porters Five Forces Analysis


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Porters Five Forces Model

Industry

competitorsSuppliers

Bargaining

power of

suppliers


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Bargaining Power of Suppliers

Suppliers are more powerful when there are few suppliers: difficult to switch

suppliers customers are fragmented

there are no substitutes for the supplies suppliers prices form a large part of the total

costs

supplier could potentially undertake thevalue-added process

supplier brand is powerful

JIT production


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Suppliers BuyersIndustry

competitors Bargainingpower of

buyers

Bargaining

power ofsuppliers

Potential

entrants

Threat of

new entrants


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Threat of Potential NewEntrants

High when barriers to entry are low

Porter identifies 7 major BTEs:

Economies of scale Product differentiation

Capital requirements

Access to distribution channels

Cost disadvantages independent of scale

Government policy

Retaliation


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Entry barriers

1) Economies of scale (Internal or external)

a) Technical - This come through an increased specialization and indivisibilities infixed costs.

b) Marketing - results from spreading the costs of marketing over higher output.

c) Financial - Larger firms can easily access to capital for low rates.

d) Risk -bearing - Diversification helps to face risks in markets.

e) Natural monopoly situation - market can be supplied by one firm for the least

costs.2) Legal barriers such as patents and franchises. Patents are exclusive licences to

exploit an invention for a given length of time and franchises are licences given to

an individual or firm to manufacture or sell a named product in a certain area for a

specific time.

3) Advertising and branding - Industries where brand names are well establishedthen difficult to enter without heavy advertising expenditure.

4) High initial capital requirements (heavy initial capital requirement is a barrier).

5) Switching costs (In some sectors switching costs are high).

6) Lack of distribution channels.

7) Restrictive practices.


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Barriers to Exist also important in porters model

1) Costs barriers - This depend on the industry-specific nature of thefirms assets. More industry specific means low second hand value and

higher exist costs.

2) Intangible assets barriers - knowledge of market and R and D can not

be resale.

3) labour costs


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Porters Five Forces ModelPotential

entrants

Industry

competitors

Threat of

new entrants

Bargaining

power of

buyers

Bargaining

power ofsuppliers

Substitutes

Threat of

substitute products

and services

BuyersSuppliers


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Threat of Substitutes

Product for Product substitution fax for post; e-mail for fax

Substitution of need

no-clean flux for cleaning solvents

Generic substitution

furniture purchases for holiday purchases

Doing without

no smoking for tobacco products

can be identified by looking at cross-rice elasticities


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Substitutes may not entirely replace existing products but

introduce new technology or reduce the costs of producing

the same products.

Substitutes may affect products in neighboring markets that

might not have originally been expected to provide competition.

Key Issues:1) Possible threats of disappearance.

2) Ability of customers to switch to the substitute.

3) Costs of providing some extra aspects of the service that

will prevents switching Likely reduction in profit margin if prices come down or are

Held.


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entrants

Industry

competitors

Threat of

new entrants

Bargaining

power of

buyers

Bargaining

power ofsuppliers

Substitutes

Threat of

substitute products

and services

BuyersSuppliers

Industrycompetitors

Rivalry among

existing firms


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The Extent of Competitive Rivalry

Different market structures have different degree of competition.

Highly competitive markets, companies have regular andextensive monitoring of the competitors behaviour.

Ex:

Price changes and matching any significant move accordingly.

2) Product changes and new initiatives.

3) Investing in new plants and reducing costs.

4) Recruiting new staffs.


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Factors affecting competitive rivalry

number of competitors

extent to which competitors are in balance

market growth rates (product lifecycle)

existence of global customers high fixed costs (price wars, low margins)

extra capacity is in large increments

differentiation acquisition of weaker companies

high exit barriers


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entrants

Industry

competitors

Threat of

new entrants

Bargaining

power of

buyers

Bargaining

power ofsuppliers

Substitutes

Threat of

substitute products

and services

BuyersSuppliers

Industrycompetitors

Rivalry among

existing firms

Suppliers

Slots & ATC : fierce competition for

limited supplyPlanes : oligopolistic suppliers

Labour : highly skilled operators for

planes; service providers

Fuel : main variable cost, volatile

high ratio of fixed to variable costs


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entrants

Industry

competitors

Threat of

new entrants

Bargaining

power of

buyers

High

power ofsuppliers

Substitutes

Threat of

substitute products

and services

Buyers

Industrycompetitors

Rivalry among

existing firms

Suppliers

Slots & ATC : fierce

competition for

limited supply

Planes : oligopolisticsuppliers

Labour : highly

skilled operators for

planes; service

providers

Fuel : main variable

cost, volatile

high ratio of fixed to

variable costs

Buyers

Segments : business v. consumer

Many alternatives for buyersPrice sensitive

Elastic demand

Rise in web as selling channel

means have more information


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entrants

Industry

competitors

Threat of

new entrants

Increasing

power of

buyers

High

power ofsuppliers

Substitutes

Threat of

substitute products

and services

Industrycompetitors

Rivalry among

existing firms

Suppliers


competition for

limited supply


Labour : highly


planes; service

providers


cost, volatile


variable costs

Buyers

Segments : business v.

consumer

Many alternatives for

buyers

Price sensitive

Elastic demand

Rise in web as selling

channel means have

more information

Potential Entrants

BTEs decreasing over time through

decreased regulation

freer competition for slotsdecline in importance of agencies

and exclusive booking systems

But

still has high MES

P t Fi F M d l


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Industry

competitors

Threat of existing firms

into new segments

Increasing

power of

buyers

High

power ofsuppliers

Substitutes

Threat of

substitute products

and services

Industrycompetitors

Rivalry among

existing firms

Suppliers


competition for

limited supply


Labour : highly


planes; service

providers


cost, volatile


variable costs

Buyers


consumer


buyers

Price sensitive

Elastic demand


channel means have

more information

Potential Entrants



freer competition for slots

decline in importance of agencies & exclusive booking systemsBut still has high MES

Substitutes

potential for substitution of need,

generic substitution and doing withoutall high

also possible to have product for

product substitution for short journeys

demand for air travel is elastic

P t Fi F M d l


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Industry

competitors

Threat of existing firms

into new segments

Increasing

power of

buyers

High

power ofsuppliers

High threat

from generics

Industrycompetitors

Rivalry among

existing firms

Suppliers


competition for

limited supply


Labour : highly


planes; service

providers


cost, volatile


variable costs

Buyers


consumer


buyers

Price sensitive

Elastic demand


channel means have

more information

Potential Entrants



freer competition for slots

decline in importance of agencies & exclusive booking systemsBut still has high MES

Substitutes

potential for substitution of need, generic substitution and doing without all high

also possible to have product for product substitution for short journeys

demand for air travel is elastic

Rivalry

many firms of similar size (but not big

enough)

simultaneous attempts to work together

(share costs) and compete (branding)

move towards price-based competitionlimited effectiveness of differentiation

Criticisms of the Model


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Criticisms of the Model

1) Assumption of organizations own interests comes first: this

is not applicable for public bodies and charitable organizations.2) Assumption that buyers have no greater importance than

any other aspect of the micro-environment. But customer is

more important than other aspects of strategy development

and is not to be treated as an equal aspects of such an

analysis.3) Consideration of suppliers and buyers as possible threats to

organization. But most companies have good co-operation

with these two parties.

4) Ignored the human resources aspects of strategy, countryculture and management skills aspects of corporate strategy.

5) Analysis is predictive rather emergent.

M i


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Merits

1) Useful starting point in the analysis and development

of corporate strategy.

2) A good logical and structured framework.

3) This analysis is complementary with analysis of industry

evolution and strategic group.

4) A good framework to analyze the firms business

environment.

F h i th titi i t f th


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Forces shaping the competitive environment of the

Engineering firm

Industry

competitors

Substitutes

Threat of

substitute products

and services

Threat of

new entrants

Potential

entrants

Bargaining

power of

buyers

Buyers

Bargaining

power ofsuppliers

Suppliers

Industrycompetitors

Rivalry among

existing firms

Changing Political

Environment

Changing Economic

Environment

Changing Technological

Environment

Changing Social

Environment

W

T

S

O


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Self-Study

a) Apply Porter's Five Forces model to yourorganization (Moratuwa University or yourHousehold) or any other firm/industry of yourchoice. What are the main drivers of competition in

your chosen industry?

b) Apply Porters Five Forces model to analyze

profitability of any industry of your choice.1) Why Coke is very profitable compared to other soft

drinks?

2) Why MTV is very profitable compared to other TV

channel?

3) Why Microsoft is leading software business?

4) Why Japanese are very dominant in automobiles?

mn 304 - market structure 1 - 4

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