MARKET STRUCTURE

1

Overview

• Context: You’re analyzing a given industry. How would youexpect market structure to depend on type of industry, type ofproduct, country size, etc

• Concepts: exogenous and endogenous entry costs, scaleeconomics and minimum efficient scale, business stealing

• Economic principle: market structure depends on many factors,but there are some regularities

2

Industry concentration

0

20

40

60

80

100

0 20 40 60 80 100

C4 (%) in Germany

C4 (%)in France 0

20

40

60

80

100

0 20 40 60 80 100

C4 (%) in Belgium

C4 (%)in France

C4 measures the combined market shares of the 4 largest firms. More on this later.

3

Market size and market structure

• Cournot competition. Cost: C = F + c qiDemand Q = (a− P)S , where S is measure of market size

• Equilibrium profit level: Π(n) = S(

a−cn+1

)2

− F

• Free entry equilibrium:

Π(n̂) ≥ 0 ≥ Π(n̂ + 1)

Π(n̂) = 0 ⇒ n = (a− c)

√S

F− 1

n̂ =

[(a− c)

√S

F− 1

]

where [x ] denotes highest integer lower than x

4

Market size and market structure

• Equilibrium value of n

− increasing in a, S

− decreasing in F , c

• Relation between S and n is increasing but less than proportional

• Intuition: higher S leads to higher n, but higher n leads to lowerp, which in turn limits the increase in n

5

Market size and market structure

0

5

10

15

20

0 5 10

n (number of entrants)

S (marketsize)

Parameter values: a = 100, c = 30, F = 100

6

Evolution of market structure

• Number of firms and firm size changes over time:

− firm growth

− firm entry and exit

− mergers and divestitures

• Evolution determined by changes in

− demand

− technology

− regulation

7

Production capacity of US brewers

Capacity (103 barrels) 1959 1967 1975 1983 1989 1998 2001 2006

10 - 100 68 36 10 15 8 77 81 83

101 - 500 91 44 19 12 7 19 19 19

501 - 1000 30 35 13 2 3 1 1 4

1001 - 2000 18 18 13 13 5 4 2 2

2001 - 4000 8 10 12 9 6 7 5 3

4001+ 2 4 15 23 20 20 20 22

Source: Elzinga, in Adams and Brock

8

History matters

• Same industry, similar countries, different marketstructures. Why?

• Branding (e.g., Heinz and Campbell’s in UK and US)

• Learning curves and other self-reinforcing processes

• Multiple technologies and multiple free-entry equilibria

9

Evolution of new industries

0

10

20

30

1975 1980 1985 1990 1995 2000 2005 2010 2015

# firms in hard drive industry

Year

active firms

entries exits

10

Exogenous and endogenous entry costs

• Compare Portugal (S = 1) and the US (S = 50)

• Basic model predicts

n̂US≈ (a− c)

√S

US

F− 1 ≈ (a− c)

√50S

P

F− 1 ≈

√50 n̂

P

• This is about right in the cement industry

• Beer industry: n̂P

= 2, whereas n̂US

= 3. Why does model fail?

11

Endogenous entry costs

• Much of the entry cost into (national brand) beer is advertising

• Advertising expenditures are roughly proportional to sales (whencomparing various countries)

• Hence, as S increases, so does F

• In the limit, if F is proportional to S , then n̂ remains flat w.r.t. S .

n̂ =

[(a− c)

√S

F− 1

]=

[(a− c)

√S

k S− 1

]=

[(a− c)

√1

k− 1

]

• Prediction: C4 decreasing (n̂ increasing) in S . However, relation isflatter in advertising-intensive industries

12

Advertising intensity

Low-adv industries A/RS (%) High-adv industries A/RS (%)

Salt 0.26–0.45 Frozen food 1.2–7.1

Sugar 0.06–0.24 Soup 2.7–6.0

Flour 0.17–0.96 Margarine 2.3–10.2

Bread 0.02–0.42 Soft drinks 1.2–5.4

Processed meat 0.30–0.70 RTE cereals 8.34–12.9

Canned vegetables 0.29–0.71 Mineral water 1.5–5.0

Sugar confectionery 1.4–6.0

Chocolate confectionery 2.9–6.5

R&G coffee 1.9–16.7

Instant coffee 2.2–11.1

Biscuits 1.9–8.0

Pet foods 4.0–8.4

Baby foods 0.9–4.2

Beer 1.0–5.43

13

Low- and high-advertising industries

0

50

100

2 4 6 8 10

C4 (%)

ln(size/MES)0

50

100

2 4 6 8 10

C4 (%)

ln(size/MES)

MES denotes minimum efficient scale. Used to compare market size across industries.

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