*Market Structure Analysis

Objectives of the Lecture1) 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 Competition b) Monopoly/Monopsonyc) Monopolistic Competitione) Oilgopoly4) To apply SCP framework to various market structures.5) To apply Porters Five Forces model to practical problems.

*The Structure Conduct Performance (SCP) Framework

Generally two approaches are used to characterize and to analyze markets.

1) SCP approach2) Porters five forces analysisThe 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.

*The Nature of SCPBasic Conditions

*SCP Framework : Industry Structurethe way in which the market is organised or the underlying factors which determine the competitive relations between sellersThe nature of productCost conditionsDemand conditionsExistence of economies of scales and scopenumber and size distribution of firms/sellers (concentration)Number and size distribution of the buyersConditions of entry and exitProduct differentiationCorporate integration Diversification

*SCP Framework : Industry Conduct the behaviour of firms as they interact with each other and customers or factors which are under control of firmPricing policiesMarketing and advertising strategiesFinancing policiesThe degree of competition or cooperationOutput decisionsR & D and innovationGrowth and merger behaviour

*SCP Framework : Industry Performance the level of efficiency achieved by firms in their use of scarce resources or indicators which measure the performance of the organizationextent of profits - normal v. abnormal profitsallocative efficiency(Marginal social benefits = marginal social costs of production)productive efficiency(Usage of resources more efficiently than before) net economic welfare - deadweight lossesSize and growth of industry outputthe development of product and technology

*Criticisms and alternatives to SCP framework

1) Structure is determined exogenously in simple SCP framework. S C P. Here no answer for the question 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 to multi-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.

*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 productCommonly 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 or level of market concentration. Index depends on the number of firms in the industry and their relative market share. Value closer to 1 says increased monopolization).Lorenz curve (This shows relationship between cumulative % of firms in the industry and the cumulative % of market share)Gini coefficient (measure of concentration in market)

*Porters Five Forces Analysis

This model also can be used to classify and analyze industries. It can 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 Rivalry2) Potential competition or threat of Potential New Entrants 3) Threat of substitute products4) The power of buyers5) The power of suppliers

*What are the key forces influencing an organization?Could these forces change:Is there a case for changing strategic relationship with suppliers?Is there a case for forming a new relationship with large buyers?Are there any technical developments that rivals could use to dramatically alter the environment?What can management do to influence these forces?Are some industries more attractive than others?Porters Five Forces Analysis

*Porters Five Forces ModelIndustrycompetitors

*Bargaining Power of SuppliersSuppliers are more powerful whenthere are few suppliers: difficult to switchsuppliers customers are fragmentedthere are no substitutes for the suppliessuppliers prices form a large part of the total costssupplier could potentially undertake the value-added processsupplier brand is powerfulJIT production

*Porters Five Forces ModelSuppliersIndustrycompetitorsBargainingpower ofsuppliers

*Bargaining Power of BuyersBuyers (or Customers) are more powerful whenthey are concentrated and there are few of them (particularly true for high volume)product is undifferentiatedbackward integration (buyers collective actions or groupings) is possibleif the selling price is unimportant to the buyers total costs supply industry comprises a large number of small operators

*Porters Five Forces ModelSuppliersBuyersIndustrycompetitorsBargainingpower ofbuyersBargainingpower ofsuppliers

*Threat of Potential New EntrantsHigh when barriers to entry are lowPorter identifies 7 major BTEs:Economies of scaleProduct differentiationCapital requirementsAccess to distribution channelsCost disadvantages independent of scaleGovernment policyRetaliation

*Entry barriers

1) Economies of scale (Internal or external)a) Technical - This come through an increased specialization and indivisibilities in fixed 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 established then 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 the firms 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

*Porters Five Forces ModelIndustrycompetitorsThreat ofnew entrantsBargainingpower ofbuyersBargainingpower ofsuppliersBuyersSuppliers

*Threat of SubstitutesProduct for Product substitutionfax for post; e-mail for faxSubstitution of needno-clean flux for cleaning solventsGeneric substitutionfurniture purchases for holiday purchasesDoing withoutno smoking for tobacco products can be identified by looking at cross-price elasticities

*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 thatmight not have originally been expected to provide competition.

Key Issues:Possible threats of disappearance.Ability of customers to switch to the substitute.Costs of providing some extra aspects of the service that will prevents switchingLikely reduction in profit margin if prices come down or areHeld.

*Porters Five Forces ModelIndustrycompetitorsThreat ofnew entrantsBargainingpower ofbuyersBargainingpower ofsuppliersBuyersSuppliers

*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.Product changes and new initiatives.Investing in new plants and reducing costs.Recruiting new staffs.

*Factors affecting competitive rivalrynumber of competitors extent to which competitors are in balancemarket growth rates (product lifecycle)existence of global customershigh fixed costs (price wars, low margins)extra capacity is in large incrementsdifferentiationacquisition of weaker companieshigh exit barriers

*Example: The Airline IndustryWhat is driving the current restructuring in the passenger airline industry?

Characterise the competitive forces in the airline industrybargaining power of suppliersbargaining power of buyersthreat of entrantsthreat of substitutescompetitive rivalry

*Porters Five Forces ModelIndustrycompetitorsThreat ofnew entrantsBargainingpower ofbuyersBargainingpower ofsuppliersBuyersSuppliersSuppliersSlots & ATC : fierce competition for limited supplyPlanes : oligopolistic suppliersLabour : highly skilled operators for planes; service providersFuel : main variable cost, volatilehigh ratio of fixed to variable costs

*Porters Five Forces ModelIndustrycompetitorsThreat ofnew entrantsBargainingpower ofbuyersHighpower ofsuppliersBuyersSuppliersSlots & ATC : fierce competition for limited supplyPlanes : oligopolistic suppliersLabour : highly skilled operators for planes; service providersFuel : main variable cost, volatilehigh ratio of fixed to variable costsBuyersSegments : business v. consumerMany alternatives for buyersPrice sensitiveElastic demandRise in web as selling channel means have more information

*Porters Five Forces ModelIndustrycompetitorsThreat ofnew entrantsIncreasingpower ofbuyersHighpower ofsuppliersSuppliersSlots & ATC : fierce competition for limited supplyPlanes : oligopolistic suppliersLabour : highly skilled operators for planes; service providersFuel : main variable cost, volatilehigh ratio of fixed to variable costsBuyersSegments : business v. consumerMany alternatives for buyersPrice sensitiveElastic demandRise in web as selling channel means have more informationPotential EntrantsBTEs decreasing over time throughdecreased regulationfreer competition for slotsdecline in importance of agencies and exclusive booking systemsButstill has high MES

*Porters Five Forces ModelIndustrycompetitorsThreat of existing firms into new segmentsIncreasingpower ofbuyersHighpower ofsuppliersSuppliersSlots & ATC : fierce competition for limited supplyPlanes : oligopolistic suppliersLabour : highly skilled operators for planes; service providersFuel : main variable cost, volatilehigh ratio of fixed to variable costsBuyersSegments : business v. consumerMany alternatives for buyersPrice sensitiveElastic demandRise in web as selling channel means have more informationPotential EntrantsBTEs decreasing over time throughdecreased regulationfreer competition for slotsdecline in importance of agencies & exclusive booking systemsBut still has high MESSubstitutespotential for substitution of need, generic substitution and doing without all highalso possible to have product for product substitution for short journeysdemand for air travel is elastic

*Porters Five Forces ModelIndustrycompetitorsThreat of existing firms into new segmentsIncreasingpower ofbuyersHighpower ofsuppliersHigh threat from genericsSuppliersSlots & ATC : fierce competition for limited supplyPlanes : oligopolistic suppliersLabour : highly skilled operators for planes; service providersFuel : main variable cost, volatilehigh ratio of fixed to variable costsBuyersSegments : business v. consumerMany alternatives for buyersPrice sensitiveElastic demandRise in web as selling channel means have more informationPotential EntrantsBTEs decreasing over time throughdecreased regulationfreer competition for slotsdecline in importance of agencies & exclusive booking systemsBut still has high MESSubstitutespotential for substitution of need, generic substitution and doing without all highalso possible to have product for product substitution for short journeysdemand for air travel is elasticRivalrymany 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

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 thanany 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.

*Merits

1) Useful starting point in the analysis and developmentof corporate strategy.

2) A good logical and structured framework.

3) This analysis is complementary with analysis of industryevolution and strategic group.

4) A good framework to analyze the firms business environment.

*Forces shaping the competitive environment of the Engineering firmIndustrycompetitors

*Self-Studya) Apply Porter's Five Forces model to your organization (Moratuwa University or your Household) or any other firm/industry of your choice. 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.Why Coke is very profitable compared to other soft drinks?Why MTV is very profitable compared to other TV channel?Why Microsoft is leading software business?Why Japanese are very dominant in automobiles?

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