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*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.
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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 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.
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*The Nature of SCPBasic Conditions
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*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
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*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
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*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
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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 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.
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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 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)
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*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
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*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
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*Porters Five Forces ModelIndustrycompetitors
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*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
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*Porters Five Forces
ModelSuppliersIndustrycompetitorsBargainingpower ofsuppliers
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*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
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*Porters Five Forces
ModelSuppliersBuyersIndustrycompetitorsBargainingpower
ofbuyersBargainingpower ofsuppliers
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*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
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*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
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*Porters Five Forces ModelIndustrycompetitorsThreat ofnew
entrantsBargainingpower ofbuyersBargainingpower
ofsuppliersBuyersSuppliers
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*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
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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 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.
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*Porters Five Forces ModelIndustrycompetitorsThreat ofnew
entrantsBargainingpower ofbuyersBargainingpower
ofsuppliersBuyersSuppliers
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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.Product
changes and new initiatives.Investing in new plants and reducing
costs.Recruiting new staffs.
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*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
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*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
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*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
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*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
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*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
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*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
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*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
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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 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.
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*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.
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*Forces shaping the competitive environment of the Engineering
firmIndustrycompetitors
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*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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