Ch 08

Front 1

The success of a firm’s organisation and strategy depends on the characteristics of:

Back 1

the market

Front 2

The market and competitive analysis:

Back 2

What is competition? What is the nature of the market? A what about the nature of competitive interactions among firms in those markets?

Front 3

Competition (1)Definition:

Back 3

If one firm’s strategic choice (adversely) affects the performance of another firm.

Front 4

Diversity?

Back 4

Yes!
Direct competitors: Strategic choice of one firm directly affects the performance of another firm.
Fe: cars, Audi versus BMW or jeans, Diesel versus Levi’s.

Indirect competitors: Strategic choice of one firm affects the performance of another, because of a strategic reaction by a third firm.
Fe: Mercedes versus Seat through Volkswagen.
Fe: Diesel versus Zara through Levi’s.

Front 5

competition in practice

Back 5

Direct competition, when an increase in price of one firm results in a loss of customers to another firm.

Or:
Firms are direct competitors when they produce products that are substitutable.

Front 6

Substitution: Two products tend to be close substitutes when?

Back 6

They have similar performance characteristics.
They have similar occasion for use.
They are sold in the same geographical area.

Front 7

How to identify competition?

Back 7

Think of:
Cross-price elasticity.



When > 0, implicates Px ↑ results in Qy ↑, or substitution.
Fe: price soda ↑, than demand lemonade (no bubbles) ↑.

Standard Industrial Classification (SIC) Codes.
Numbers for the identification of products and services.
Fe: 822 Colleges & Universities subdivision of 82 Educational services  Erasmus, UT, UVA.
Warning: these are not substitutes by definition!!!

Geographic  Flow analysis.

Front 8

the market definition?

Back 8

Definition:
A market consists of buyers and sellers of a good or service.

Often described by:
The degree of concentration of sellers of a good or service.
Fe: Monopoly – 1 seller.
Fe: Perfect competition – many sellers.

Or:
Market structure.

Front 9

Perfect competition?

Back 9

Characterised by competitive equilibrium.
Firms are forced to produce as efficiently as possible  inefficient firms drop out.
No abnormal profits.
 see book and micro.

Front 10

imperfect competion?

Back 10

Monopolistic competition.
Oligopoly.
Monopoly.
 see book and micro.

However: Only a static view on competition!

Front 11

what are the main facts of market structure and compettion?

Back 11

So also: Dynamic view of competition!

Selection of new entrants:
New firms learn about their relative productivity.
New firms either exit or grow.
As firms grow they profit from scale economies, transition from perfect to imperfect competition.

Schumpeter (Austrian school):
Competition is driven by innovation (product/process).
Innovative firm becomes monopolist  monopoly profits.
Other firms catch up.

In short: Market structure, the strategy of the firm and firm performance and interrelated!

Front 12

What is SCP? and its main features?

Back 12

Structure-Conduct-Performance (SCP) Harvard School: Highly influential in industrial organisation from 1950s to 1970s.
Forward causation:
Market structure (concentration) affects conduct (strategy) which in turn affects performance (market power).
Market structure is driven by basic supply and demand conditions (is considered exogenous).
Performance is the measured outcome.

High concentration is bad for consumers (according to SCP) and paved the way for antitrust legislation.

Front 13

How to measure structure? Market concentration:
SCP

Back 13

(N-firm) concentration ratio: the combined market share of the N largest firms.
Herfindahl index: sum of the squared market shares.

sum of market share squared ech firm in %

Si represents the market share of firm i.

Front 14

Also measure with Entry barriers?
SCP

Back 14

Yes, among others:
Minimum efficient scale.
(Sunk) capital investments.
Advertising.
Research and Development.

Front 15

How to measure conduct?
SCP

Back 15

The policy and strategy of the firm in its widest sense:
Pricing of products.
Investment.
Mergers and acquisitions.
Product choice.
Collusion.

Front 16

How to measure performance?
SCP

Back 16

Price cost margin.
Lerner index (in book PCM):
L=(P-c)/P
where P is price and c is marginal (variable) cost.
Lerner index measures market power!
Profitability.
Fe: Return on equity or return on assets.
Production efficiency.
Innovative performance (number of patents).

Front 17

Hypothesis 1:
SCP empirics

Back 17

Market power increases when market concentration increases.
Literature review by Weiss (1974) shows that most studies find a positive effect, but the effect is small (10% increase in C4 increases Lerner index by 1.2%).

Front 18

Hypothesis 2:
SCP empirics

Back 18

The larger the entry barriers, the higher the exercise of market power.
Effect of barriers to entry more robust and significant than effect of concentration.
Minimum efficient scale, capital intensity, R&D to sales ratio advertising to sales ratio are all positively correlated with profit.

Front 19

Chicago Reverse causation:

Back 19

Reverse causation:
Firms make choices (such as innovation), which not only influence performance, but also affect market structure.
More efficient firms are more profitable and tend to grow large (performance influencing structure).
Chicken and egg story with SCP  Endogeneity.

Monopoly is often transitory:
Entry (or threat of entry) is important.
Firms can pursue strategies to influence entry decisions of other firms (thus conduct affects structure).

Front 20

What is the conclusion and collusion hypothesis of harvard and chicago?

Back 20

Collusion hypothesis: Argues that a positive relation between concentration and profitability is evidence of collusion (or other abuses of market power) designed to enhance profit.
Fe: OPEC (Organization of Petroleum Exporting Countries).

Efficiency hypothesis: Argues that a positive relationship between concentration and profitability reflects a natural tendency for efficient firms to be successful and to become dominant in their industries.
Fe: Microsoft.

Front 21

Antitrust Law (2)??

Back 21

European competition law (EC-convention):
Reflects USA competition law.
http://ec.europa.eu/competition/antitrust/overview_en.html

Article 101 (ex. 81): Restrictive prices and price agreements.
Market sharing.
Price fixing.
Quota agreements.

Prohibits cartels:
Cartel: group of firms that attempt to reduce the degree of competition among each other.

Front 22

Example??

Back 22

Fines: Recent years have seen record-breaking fines being imposed by the EC on firms found guilty of taking part in a cartel.

Elevator conspiracy 2007, highest fine to date:
Kone, Mitsubishi, Otis, Schindler, ThyssenKrup.
Total fine: € 990 million (!).

Computer chip cartel 2010:
10 firms including Samsung, NEC, Hitatchi, Mitsubishi.
Total fine: € 331 million.

2011: Already € 315 million of fines imposed.

Front 23

Antitrust Law (3)

Back 23

European competition law (EC-convention):
Important for mergers and acquisitions.
http://ec.europa.eu/competition/antitrust/overview_en.html

Article 102 (ex. 82): Abuse of dominant position.
Excessive pricing.
Price discrimination: discounts and rebates.
Refusals to make deals with particular companies.

So:
Similar to cartels, merger or acquisition is a formal agreement to cooperate.
Prevent the creation or strengthening of a dominant position that would impede effective competition in the common market.

Front 24

Cartels? Why do they arise and why do they exist?

Back 24

Dynamic view: consider multiple periods instead of 1 period.
Nash equilibrium in a repeated game can be to collude.
Equilibrium is a tit-for-tat strategy.

Front 25

recent research? From the 80s onwards:

Back 25

Game theory (see example cartel):
Detailed research on strategic interaction between firms.
New empirical industrial organisation:
Structural empirical modelling.

Front 26

conclusion for competitors and competition

Back 26

There is competition when products are substitutable.

Market structure is often characterised by the degree of concentration of the number of sellers in a market.

Market structure, firm strategy and performance are interrelated.
SCP / Chicago.
High degree of concentration may be bad for consumers.
Therefore, antitrust legislation.