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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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Porters Five Forces Model
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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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
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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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
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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Porters Five Forces ModelPotential
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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Porters Five Forces ModelPotential
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
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
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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Porters Five Forces Model
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
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
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 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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Porters Five Forces Model
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
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
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 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?