Microeconomics Oligopoly Malaysia Railway Market Feb 2010_do Not Use Without Permission of Ralph Yew

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ECO 501 – Economics for Business

Unit Coordinator: Dr James Nayagam

Assignment 1

Due: 20th February 2010

The Railway Technology Companies in Malaysia – An Oligopoly Market

Student ID: Mr RALPH YEW (10166320)

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TABLE OF CONTENTS

I. Introduction 3

II. Railway Technology Companies in Malaysia- an Oligopoly 4

III. The Good vs Bad of Oligopoly 6

IV. Analysis Of The Malaysia’s Railway Technology Players 9

V. Porter’s Five Forces of Competitive Analysis 13

VI. Two Main Competitive Force Identified in AnsaldoSTS 16

VII. Game Theory 17

VIII. Strategic Plan of Action for AnsaldoSTS 19

IX. Conclusion 21

X. References 22

XI. Bibliography 23

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The Railway Technology Companies in Malaysia – “An Oligopoly Market”

I. Introduction

Malaysian railway industry is a government entity which is under the Malaysian

Railway ( KTMB). The supplier and vendor for the railway technology can be

categorized under the oligopoly market. An oligopoly is a market dominated by a

small number of strategically interdependent firms. In such a market, each firm

recognizes its strategic interdependence with others. The strategic interdependence

requires that only a few firms dominate the market

The strategic interdependence can becomes weaker as the market becomes smaller,

like the case of Malaysian railway. Traditionally, the suppliers and players will create

strategic barriers designed to keep out potential new competitors. Such example are

like requiring the product to have type-approval from Malaysian Railway or the

product be tested for tropicalised condition if there are qualify for the use of Malaysia

railway market. The effort required considerable time and investment. Some other

form of legal barriers may include patents and copyrights, Government legislation.

Oligopoly present a great challenge to business economist at times and one approach

is the game theory. Game theory gave good insights into oligopoly behavior. In Game

theory, a player’s strategy must take account of the strategies followed by other

players. Game theory analyzes oligopoly decisions as if they were games. In some

games, one or more players may not have a dominant strategy. Other game may have

two players will have a Nash equilibrium as long as at least one player has a dominant

strategy. When neither player has a dominant strategy, then we need a more

sophisticated analysis to predict an outcome to the game. The simplest form of

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cooperation is explicit collusion. Collusion is when the oligopolists agree in formal or

informal to limit competition between themselves.They may set output quotas, fix

prices, limit product or development or agree not to ‘poach’ each others market

( Sloman, Hinde, 2007)

II. Railway Technology Companies in Malaysia – an oligopoly market

I worked for AnsaldoSTS ( formerly Union Switch & Signal ) a multinational

company which in 2007 has acquired an established Australian rail system company

called Union Switch & Signal. In Malaysia, the company Union Switch & Signal was

established in 1998. In Malaysia the railway technology are control by a few major

players. They are Siemens Mobility, Invensys, Alstom Transport and AnsaldoSTS.

Here for this paper on microeconomics we will look at the analysis of their oligopoly

market and examine the key competitive forces affecting our local the rail industry.

The oligopoly players are supplying the homogenous product namely the signaling,

point machine, wayside equipment and automated train protection to the Malaysian

Rail (KTMB). The Malaysian Rail is under our Ministry of Transport is the sole

provider for our national public rail transportation and rail cargo transportation in the

country. In line with the focus of our Government to further improve our public

transportation usage and modernization of our railway track in this country, our

Government has embarked on a mission to implement the electrification of double

track railway lines spanning from the north section of Padang Besar to Ipoh ,

stretching to Rawang and continue to the main central station KL Sentral. This has

created tremendous opportunity for the few players to position themselves strongly to

specify their track equipment to the Malaysian Rail ( KTMB) and to win major rail

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contracts that amount to billions of ringgit. Until now it is still dominated by a few of

the major European rail companies.

The oligopolists railway companies operating here can collude among the players.

The oligopolistic market may be described as a small-enough number of sellers of a

homogeneous or differentiated product that each knows the identities and pays careful

attention to the actions of competitors in the market. Since I worked for AnsaldoSTS,

one of the aggressive global rail players in the market I also kept in touch with the

other railway companies. From time to time AnsaldoSTS also use the competitors’

products for our project. Recently, AnsaldoSTS won a huge railway signaling project

for the Malaysian’s north section of Padang Besar to Ipoh with a length of 330km

awarded to us by MMC-Gamuda. AnsaldoSTS is now a dominant rail technology

player with the signalling project that span more than 450km of Peninsular Malaysia.

A decision strategy is important in oligopoly because oligopolistic sellers know the

identities of their competitors and have some pricing discretion. Possible oligopoly

behavior patterns include ignoring competition, price warfare, price rigidity,

cartelization, collusion, and price leadership/followership. The price warfare may

occur due to unwariness of competitors, or may be initiated deliberately to drive

competitors out of business. Sometimes the situation, may lead to extreme price

rigidity in oligopoly. Where there are antitrust laws that are vigorously enforced, price

leadership or followership will likely emerge as the most common form of oligopoly

behavior. The oligopolistic firm which naturally prefers the lowest price in order to

maximize profits will tend to be the price leader in the market. The potential price

leader may not be the actual price leader in an oligopolistic market.

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Although oligopolistic industries tend to be diverse, they also tend to exhibit several

behavioral tendencies among them : i) rigid prices ii ) nonprice competition

iii )interdependence, iv) collusion and v) mergers and acquisition

III. The Good versus Bad of Oligopoly

The Good of Oligopoly are firstly the advantage of economies of scale and secondly it

is able develops a culture of continuous product innovations.

On advantage of economies of scale, oligopoly company like the railway players can

take advantage of economies of scale that reduce prices from its advanced supply

chain management, just in time warhousing and and greater production costs. As huge

companies, they can "mass produce" at low average cost. Example many modern

consumer goods like computers, aircraft, and consumer household products--would be

more expensive if produced by a large number of small firms rather than a small

number of large firms like the oligopolists.

On the advantage of a culture of innovations, here among the four market structures

( refer Figure 1 : Four Common Market Structure) of perfect competition,

monopolistic, oligopoly and monopoly. The oligopoly has the likelyhood to develop

product innovations from the advancement of R&D technology, expansion of

production capabilities, being able to promote economic growth and better living

standards. Oligopoly has both the motivation and the opportunity to pursue innovation.

Its motivation arises from access to abundant resources and the interdependent

competition.

While the bads of oligopoly is firstly it promotes inequality because concentration of

wealth and income. Oligopoly tends to increase the concentration of wealth and

income with single pursuit of profit maximization at the expense of its buyer. The

concentration of wealth may sometime

economy, the society, and the local politics. S

Secondly, oligopolists tend

inefficiency for oligopoly

its huge financial resources to undertake mega projects and deals

with market control, an oligopoly charges a higher price and produces less output than

the efficiency benchmark of perfect competition. In real case,

the worst efficiency offender in the real world, because perfect competition does

exist, and can go so bad until a time it

Figure 1 : Four Common Market Structures


may sometime be abused to exert influence over the

and the local politics. Society stands to lose as a result of it

Secondly, oligopolists tend to be inefficient in the allocation of resources. The

oligopoly is it does not efficiently allocate resources especially with

its huge financial resources to undertake mega projects and deals. Like any


of perfect competition. In real case, oligopoly tends to be

the worst efficiency offender in the real world, because perfect competition does

and can go so bad until a time it subject to corrective government regulation.

Figure 1 : Four Common Market Structures

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to exert influence over the local

stands to lose as a result of it.

the allocation of resources. The

especially with

. Like any company


oligopoly tends to be

the worst efficiency offender in the real world, because perfect competition does not

subject to corrective government regulation.

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Figure 2 :A Model of Dominant-Firm Price Leadership

In Figure 2, the market demand is Dm. The competitive supply, Sc, is the sum

of the marginal cost curves of the competitive company. The locus of the

dominant company's demand curve, Dd, is found by subtracting the

competitive supply from Dm at each possible price. The dominant company

then sets price at P1 to maximize its profits by selling lesser output Q1, while

the competitive companies behave as purely competitive price takers to sell

quantity (Q2-Q1). This form of oligopolistic market organization is happening,

and may continue as long until certain antitrust law is enforced and the

dominant company behaves itself. The dominance of the dominant company

may break down when one or more of the competitive competitors begins

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price experimentation or new product differentiation/in the effort to win and

capture a larger share of the market.

IV. The Malaysia’s Railway Players’ Performance for 2008 to 2009

Based on the performance of respective players, for year 2008 we observed that the

market leader position achieved by Alstom Transport ranked first place followed by

Siemens Mobility, AnsaldoSTS and Invensys. For all the four railway players most of

their market share came from European market due to the modernization of their

railway infrasturucture and a move to adopt European Rail Traffic Management

(ERTMS) standards. As such the rail business is highly profitable. In addition to that

between 2008 till 2009 when the financial meldown happen worldwide, most

government are injecting financial stimulus package in the form of infrastructure

upgrades work resulting in the railway sector experiencing strong growth for all the

four players. All the 4 major oligopoly rail technology players operating in Malaysia

experienced double digit growth with one of the players Invensys almost doubling its

revenue for 2009.

I have done a very comprehensive research into the performance of the 4 leading rail

technology players with sizable projects in Malaysia. There are Invensys, Siemens

Mobility, AnsaldoSTS and Alstom Transport. All of them are established European

rail players.

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Source : Annual Report 2009 Siemens, Invensys, ASTS & Alstom Transport

The Rail Technology Players New Order 2008 (EURO )

Invensys

Siemens Mobility

AnsaldoSTS

Alstom Transport

Performance of Rail Technology Players for 2008

Invensys

Siemens Mobility AnsaldoSTS

Alstom

Transport

Order (EURO )mill

493

5,841

1,269

7,371

Revenue ( EURO )mill

620

7,842

1,105

5,529 Operating profit

(EURO)mill 107

(230)

117

395

Performance of Rail Technology Players for 2009 ( source

Annual Report 2009 Siemens, Invensys, ASTS, Alstom)

Invensys


Alstom

Transport

Order (EURO )mill

1,113

6,442

1,750

8,100

Revenue ( EURO )mill

731

6,766

1,170

5,700

Operating profit

(EURO)mill 154

390

124

408

Revenue of Rail Technology Players for 2008

Invensys

Revenue ( EURO )

mill


Rail Technology Players


Invensys


620

7,842

1,105


Invensys

Siemens Mobility

AnsaldoSTS

Alstom Transport

Rail Technology Players Revenue for 2008

(EURO )Invensys

Siemens Mobility

AnsaldoSTS

Alstom Transport

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AnsaldoSTS

Alstom

Transport

1,105

5,529

The Rail Technology Players

Siemens Mobility

AnsaldoSTS

Alstom Transport

Siemens Mobility

AnsaldoSTS

Alstom Transport


Invensys

Revenue ( EURO)

mill

Operating Profit of Rail Technology Players for 2008

Invensys

Operating profit (EURO)

mill 107

Rail Players Revenue for

-300

-200

-100

0

100

200

300

400

500

Invensys Siemens Mobility

Rail Technology Players Operating Profit for 2008 (EURO) mill


Invensys


731

6,766

1,170



(230)

117

Rail Players Revenue for 2009 (EURO )

Invensys

Siemens Mobility

AnsaldoSTS

Alstom Transport

Siemens Mobility

AnsaldoSTS Alstom Transport


Operating profit ( EURO)

12

AnsaldoSTS

Alstom

Transport

1,170

5,700

Alstom Transport

395

Siemens Mobility

Alstom Transport

Rail Technology Players Operating


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Invensys Siemens Mobility AnsaldoSTS Alstom Transport

Operating profit

(EURO) mill 154

390

124

408

V. Porter’s Five Forces of Competitive Analysis

The Porter's 5 Forces Competitive Analysis is powerful business strategies tool for

understanding where power lies in a business situation. It helps the company to

understand both the strength of their current competitive position, and the strength of

a position they plan to move into. Refer Figure 3 : Porters Five Forces

0

100

200

300

400

500

Invensys Siemens Mobility

AnsaldoSTS Alstom Transport



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Figure 3 : Porters Five Forces Competitive Analysis

The strongest competitive force or forces determine the profitability of an industry

and become the most important to strategy formulation. With a clear understanding of

where power lies, the railway technology companies can take fair advantage of a

situation of strength, and further improve a situation of weakness, thus avoiding

taking wrong steps. Conventionally, the five forces tool is used to identify whether

new products or businesses have the potential to be profitable and to understand the

balance of power in other situations too.

Porter’s Five Forces of Competitive Analysis mentioned that there are five important

forces that determine competitive power in a situation. The five forces are highlighted

here below:

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Firstly, the Supplier Bargaining Power, it potrays how easy it is for suppliers to drive

up prices. This is driven by the number of suppliers of each key input, the uniqueness

of their product or service, their strength and control over the market, the cost of

switching from one to another. The fewer the supplier choices you have, and the more

you need suppliers' help, the more stronger the suppliers are. All the railway

technology operating here sourced their signallling equipment from Europe and the

suppliers’ delivery lead time is a concern to the buyer.

Secondly, the Buyer Bargaining Power, potraying how easy it is for buyers to drive

prices down. Again, this is driven by the number of buyers, the importance of each

individual buyer to the business, the cost to them of switching from your products to

those of someone else, and so on. In the case of Malaysian Railway ( KTMB) they are

the sole buyer, which mean they are often able to dictate certain terms to all the

vendors operating in Malaysia. Malaysian Railway will always practice calling for a

tender when purchasing the railway equipment.

Thirdly, Competitive Rivalry, explaining the importance the number and capability of

the competitors. Meaning if many competitors, thus they may offer equally attractive

products and services. Such is the situation that if suppliers and buyers do not get a

good deal from you, they will go elsewhere. On this note, because my company

AnsaldoSTS has most of its signaling product type-approved for Malaysian Railway

thus no-one else can supply this proprietary product, thus AnsaldoSTS have

tremendous strength here having monopolized the north section of the signaling with

its proprietary Microlok interlocking equipment.

Fourthly, Threat of Substitution, with a few established overseas railway company

trying to specify the rail signaling product using overseas consultants to the Malaysian

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Railway . The customer in the case of KTMB is also finding different new product to

be considered as an alternative. If substitution is easy and substitution is viable, then

this weakens further power of AnsaldoSTS as the incumbent.

And fifthly, Threat of New Entrant, here explaining that power is also affected by the

ability of other new railway player trying to enter this market. If it costs little in time

or money to enter your market and compete effectively, if there are few economies of

scale in place, or if currently railway in Malaysia have little protection for key

technologies, then new competitors can quickly enter your market and weaken your

position. Today AnsaldoSTS has strong and durable barriers to entry, they can

preserve a favorable position and take fair advantage of it. Among other things the

client KTMB is demanding better discount from AnsaldoSTS the incumbent supplier

for its signaling spare parts equipment.

VI. Two Main Competitive Force Identified in AnsaldoSTS

I would like to highlight two main competitive forces that the oligopoly player has use

to its advantage. Firstly, the main competitive forces here is the rivalry competition

forcing AnsaldoSTS to innovate their signalling product offerings with more newer

product as a result of more R&D and their strategy of doing more acquisition of

strategic technology firm like Selex Communication to enhanced further their position

in this very lucrative railway business. Apart from that AnsaldoSTS being the

incumbent railway technology has type-approved many of its signal product like its

MicrolokII interlocking system and their on-board Automatic Train Protection as a

first choice product approved for the use by Malaysian Railway. AnsaldoSTS has also

tried to hired local Malaysian contractor to deliver the project resulting in better profit

maximization for the organization.

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Secondly, the main forces being the factor of threat of buyers’ bargaining power.

Here, AnsaldoSTS has been very successful in ensuring the buyer KTMB prefer a

professional working experience with the AnsaldoSTS’s local team . Among other

things the client KTMB has worked with the management of AnsaldoSTS and the

experienced key project team resulting in a very strong relationship chain which is

very hard for other player to penetrate. Besides, when AnsaldoSTS installed and

commission its railway system in Malaysia they are putting in all proprietary

technology where no other players can source or operate easily. Likewise, the railway

players like Siemens Mobility, Invensys and Alstom Transport are doing the similar

tactics of specifying and installing their own standard. Here, the buyer is always at the

mercy of this railway technology companies, having no choice but to get the spare

parts and components from this dominating railway players. As we will see,

defending against the competitive forces and shaping them in a company’s favor are

crucial to strategy

VII. Game Theory

Game theory is technique often used to analyze interdependent behavior among

oligopolistic firms. Game theory illustrates how the choices between two players

affect the outcomes and end results of a "game."

Refer Figure 4 below, to the

oligopolistic firms, AnsaldoSTS

spending on advertising and marketing

Figure 4 : Railway Player

In the top left quadrant, if AnsaldoSTS

and marketing, then each receives $20

But, as shown in the top right quadrant, if

AnsaldoSTS does not, then

receives $10 million

However, in the lower right quadrant, if NEITHER

spend on advertisement, then each receives $25 million in profit. Each c

receive more because they do not incur any advertising expense.

to the extreme right illustrates the alternative facing

oligopolistic firms, AnsaldoSTS and Invensys Rail, as they ponder the prospects of

and marketing their signaling products.

: Railway Players Spending on Advertising and Marketing

e top left quadrant, if AnsaldoSTS and Invensys both decide to spend advertising

and marketing, then each receives $20 million in profit.

But, as shown in the top right quadrant, if Invensys spend on advertisement and

does not, then Invensys receives $35 million in profit and

However, in the lower right quadrant, if NEITHER AnsaldoSTS or Invensys

ment, then each receives $25 million in profit. Each c

receive more because they do not incur any advertising expense.

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right illustrates the alternative facing two

, as they ponder the prospects of

Advertising and Marketing

spend advertising

spend on advertisement and

AnsaldoSTS

Invensys decide to

ment, then each receives $25 million in profit. Each company

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Alternatively, as shown in the lower left quadrant, if Invensys advertises but

AnsaldoSTS does not, then Invensys receives $35 million in profit and AnsaldoSTS

receives lower return of $10 in profit. Invensys gets a boost in profit because when

advertising it attracts customers away from AnsaldoSTS market share.

Game theory indicates that the best choice for AnsaldoSTS is to advertise, regardless

of the choice made by Invensys. And Invensys faces EXACTLY the same choice.

Regardless of the decision made by AnsaldoSTS must be wise to advertise.

The end result is that both firms decide to advertise. In so doing, they end up with less

profit ( only $20 million each), than if they had colluded and jointly decided not to

advertise ( the profit return is $25 million each). The final analysis illustrates the two

companies cooperating through collusion are better off than if they compete in the

market.

VIII. Strategic Plan of Action for AnsaldoSTS for next 5 years

The world’s rail market remained strong during the year with spending underpinned

by the need to improve mainline rail and mass transit infrastructure, recognising the

importance of rail as an environmentally sustainable and economically efficient

means of transport for both passengers and freight. Another point is major cities

worldwide trying to reduce the numbers of passenger cars on the road by promoting

and improving the passengers ridership on rail by as much as 25-30% of the total

transportation. A case here is the Malaysia’s Klang Valley Light Rail Line Extension

for the Kelana Jaya and Ampang Line to extend the lines but almost up to 30km,

giving all the present rail players a significant chance to win the billion ringgit

contract.

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The annual result of AnsaldoSTS for end 2009 has laid the foundation with

consideration of the positive results of the financial year with production volumes

higher than, the strong performance posted in 2008. The initiatives to boost cost

efficiency in order to increase profitability will continue. In Malaysia and worldwide

the railway signalling and transport systems markets are still growing overall,

although in certain country like Italy and France which is comes to maturity.

AnsaldoSTS is continuing to pursue opportunities in high-growth countries with

substantial capacity for infrastructure investment, such as China, India and Russia,

with some recent acquisitions.

For the growth beyond 2010, AnsladoSTS will search for opportunities in the

transport systems business around the world supported by the systems experience of

its group and its subsidiaries their signalling business unit in the various markets.

The Company’s positive financial situation allows it to closely monitor happenings in

the sector in order to search for and select any investment opportunities in support of

growth, analysing possible acquisitions or equity investments in companies offering a

complementary presence in new markets of interest to AnsaldoSTS or those having a

product portfolio that would expand the Group’s existing range of solutions in the

railway business. So the current move to acquire some strategic companies with rail

product and specialization is crucial for AnsaldoSTS to compete with a wider product

portfolio. Also the urgent need to ramp up its research and development to come up

with newer signaling product like driverless CBTC train system, solid state

microprocessor interlocking and advanced train control software to at least match the

competitors or be better in term of innovation.

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From a global economic viewpoint of having a more clean and sustainable public

transportation will augurs well for AnsaldoSTS to expand its market territory ahead of

its competition to the new emerging market like Brazil, Russia, India and China. The

success in Indian railway market is a testimony of its technology expertise in

signaling interlocking product complement with local supports. A positive growth for

the next 5 years for AnsaldoSTS will be possible with the support of a good human

capital development and retention policy. Meaning AnsaldoSTS must reward the

good performer in the company to ward of the competition in an intense war for talent

in this niche rail market. And, lastly the continuous effort to enhance its customer

relationship management with better support and better on-time project delivery.

IX. Conclusions

The lesson from this micro economics paper has taught me that the importance of

understanding the dynamics of the micro economics using Porter’s five forces of

competive analysis to develop a strategic game plan for AnsaldoSTS to compete and

move up their position and to further sustain the organization’s market share and thus

their better position in the global railway industry.

By understanding the current global megatrends I can better address this challenges.

There are like global climate change, urbanization, globalization, demographic change,

a move into green technology. Here, my organization will be able to aligned its

strategy to some up with solution in addressing the urban mobility and environmental

friendly modern transportation.

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With the understanding of the theory learned and analyzed here I can further work on

a strategic business plan to allow the company AnsaldoSTS to remain competitive and

successful in winning more contracts in the ever changing and shifting of the business

terrain in this new post recession global economy.

X. REFERENCES

1. Sloman and Hinde, 2007, Economics for Business, Prentice Hall,

2. Porter, March-April 1979, How Competitive Forces Shape Strategy, Harvard Business Review School, page 86-93

3. Useem, 1999, Foundation of Leadership, Wharton, University

Pennsylvania 4. Begg D. and Ward D.,2006, Economics for Business, Berkshire, McGraw

Hill 5. Layton, A Robison, Tucker, Economics for Today,Thomson Australia

2004 6. Ehnke, Fulton, Akridge, 2004, Industry Analysis- Five Forces, Purdue

University 7. Hall & Liebermann, 2004, Economics Principles & Application 8. Sweezy, 1939, Demands Under Condition of Oligopoly, Journal of

Political Economy 9. Razeto , Nov 2009, AnsaldoSTS SpA Annual Report 2009, www.ansaldo-

sts.com, London 10. Investor Relations Invensys plc, Dec 2009, Annual Report and Account

2009, www.invensys.com 11. Investor Relations Siemens , Nov 2009, Annual Report 2009,

www.siemens.com/annual-report 12. Investor Relations Alstom, Dec 2009, Annual Report 2009, www.alst

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XI. BIBLIOGRAPHY

Bernheim, B. D. and Whinston, M. D. (2008), Microeconomics, McGraw-Hill.

Frank, R. H. (2008), Microeconomics and Behaviour, 7th ed., McGraw-Hill.

Pindyck, R. S. and Rubinfeld, D. L. (2005), Microeconomics, 6th ed.,

Pearson/Prentice-Hall international edition.

Perloff, J. M. (2007), Microeconomics, 4th ed., Pearson.

Perloff, J. M. (2008), Microeconomics: theory and applications with calculus, Pearson.

Salvatore, D. (2003), Microeconomics: theory and applications, 4th ed., Oxford

University Press.

Snyder, C. and Nicholson, W. (2008), Microeconomic Theory: basic priciples and

extensions, 10th ed., London : Thompson South-Western.

Sice, P., E. Mosekilde, A. Moscardini, K. Lawler and I. French. (2000), Using System

Dynamics to Analyse Interactions in Duopoly Competition.

Varian, H. (2006). Intermediate Microeconomics: a modern approach, 7th ed., W.W.

Norton.

Documents

Microeconomics Oligopoly Malaysia Railway Market Feb 2010_do Not Use Without Permission of Ralph Yew