101 Ways to Promote Your Business for Maximum Profits

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					 Economics of industry
The economic consequences of
market power, the foundations of
       industrial policies




            industrypartsa/b       1
                       Intro
• The economic consequences of the size/ scope of
  firms, of the structure of markets, of the existence
  and exercise of market power.
• The economic consequences of the firm’s search
  for, use and protection of market power.
• The S-C-P (mainstream textbook) view of the
  world, some alternative views, evidence and
  interpretations.
• A deliberately critical evaluation. Economics is
  about learning how to think not what to think.
                       industrypartsa/b                  2
                 References etc
• For outline/ suggested textbook/ and references see class
  guide. Remember I am not following the textbook closely.
  The textbook is complementary not a substitute. It has a lot
  more detail than I can present in the lectures. It should be
  pretty obvious where to look for extra details in the
  textbook for the issues as they arise so only from time to
  time will I refer specifically to the textbook.
• NB there are some supplementary word based notes ( one
  on market power, one on oligopoly etc) as well as the
  lecture slides on the web pages.



                          industrypartsa/b                   3
                   L&W text
    Chap 1.2 (views of competition),
•   2.5/ 2.6 (basics of case for competition),
•    10.3 (price discrimination and
    significance),
•   14.2 (Arrow model and innovation)
•   and 17.2 and 18.2 (more on basic case
    against m power)

                      industrypartsa/b           4
                        Parts
• A. The problem outlined: the monopoly model,
  monopoly power, and economic efficiency
• B. The debate started: examining the foundations of the
  mon. model
• C. The debate continued: beyond monopoly. Oligopoly
  models, cooperative and non-cooperative, and what these
  tell us about the consequences of market power
• D. The evidence considered: statistical evidence on the
  effects of market power and the interpretation of the
  evidence
• E. Other aspects: consequences re vertical integration/
  M&As discussed later

                        industrypartsa/b                    5
 Economic consequences of firm
     s/e/p market power ?
• For firm’s profits (private interest)
• For economic efficiency broadly defined
  (social/ public interest)
• And the idea of a ‘social welfare loss’ from
  monopoly and oligopoly (m power).
• Including consequences of actions such as
  vertical restraints and M&As?

                   industrypartsa/b              6
               Watch the words
• What firm’s are actually seeking for is economic profit or
  economic added value (EVA) but mainstream texts on IO
  focus exclusively on market power as the means to
  achieving this end so it is these means which they
  investigate and condemn. Other possible sources of
  success, such as entrepreneurial insight, innovation, or
  superior organisation qualities, aren’t even considered.
  Firms don’t succeed because they are good at what they do
  but because they acquire and exploit ‘market power’.
• As we will argue later this is both strange and
  questionable. It seems to assume something about the
  determinants of business performance, of the sources of
  business profit, rather than treating this as an issue to be
  investigated.
                          industrypartsa/b                   7
                Focus issues
• How satisfactory is the economic case against
  market/ monopoly power as a foundation for
  public policy actions against dominant firms,
  collusion, mergers, etc. In particular how good is
  the evidence.
• Contrasting two schools of thought: the
  mainstream Harvard SCP school and its Chicago
  school critics.
• Leads us to a consideration of competition policy
  itself.

                      industrypartsa/b                 8
           Competition policy
• ‘In this report comp policy is used as a convenient
  term to cover the policy on monopolies/
  mergers/restrictive practices/resale price
  maintenance/ and other ‘uncompetitive practices’.
  The criterion for action …is the public interest …
  defined in terms of industrial efficiency’
• Government ‘Review of Monopoly and Merger
  Policy’, 1978
• This tells us what C policy is about and its
  underlying objectives.

                      industrypartsa/b                  9
• Com Pol is an element of wider government
  involvement in the economy called ‘industrial
  policy’ which is concerned in principle with state
  efforts to improve overall economic performance
  by, it is hoped, making the economy more
  dynamic and efficient.
• Gov cannot do this directly, by dictation, so it has
  to approach it indirectly by acting on the business
  environment (promoting competition) and on the
  actions of firms seeking market power.
                       industrypartsa/b              10
                  Assumption
• On which policy rests is that there is a direct and
  significant link between (market) Structure-(firm)
  Conduct and (market) Performance (efficiency).
  Hence ‘SCP’ school. The theoretical basis being
  the Harvard school of industrial economics as
  developed by Bain, Caves, Porter et al.
• But these views are not universally accepted.
  Some, more sceptical, economists believe there is
  no really satisfactory verifiable basis for c policy,
  that it could end up doing more harm than good.

                       industrypartsa/b               11
              Some minority views
• There is also a (perhaps extreme) minority view (liberalism) which
  promotes competition as an end in itself, not just as a means to
  industrial efficiency. This would promote more competition even if
  this damaged industrial efficiency (eg Charles Rowley). Belief is that
  dispersed economic power is vital to democracy and personal
  responsibility and thus is opposed ‘big business’ power in principle.
• At other extreme are those who think monopoly is fine as long as it is
  socialised and publicly owned. Belief here is that m is ok if it seeks the
  ‘public interest’ rather than profit. Once official UK labour party
  policy. The labour party has usually been perfectly happy to promote
  public monopoly whilst attacking private monopoly as exploitative. In
  fact a lot of competition policy in this country has been developed
  under labour governments.


                                industrypartsa/b                          12
    Part A: The problem outlined
• Problem with which c policy seeks to deal is the
  ‘presumed’ socially detrimental consequences of a firm or
  a group of firms seeking and using market power.
• The detriments are believed to arise as a result of economic
  efficiency losses which theory suggests are associated with
  market power and the (damaging) efforts of powerful firms
  as they seek to extend/ exploit/maintain their power. The
  problem has two aspects:
• 1. The monopoly or dominant firm problem
• 2. The collusion or restrictive practices problem
  (cooperative cartels/ collusive tendering) sometimes
  referred to as a ‘complex monopoly’.

                          industrypartsa/b                  13
  The case against m power and
      for more competition
• Is that in general it harms economic
  efficiency, broadly defined, compared to
  competitive structures (we take knowledge
  of the competitive model as given here).
• The case against covers: allocative effic,
  organisational effic, and dynamic efficiency
  (and some other complaints such as
  ‘wasteful’ advertising).
                   industrypartsa/b          14
                            NB
• The case against market power is developed from a
  comparison of two simple extremes (pc and m). The
  implication being that if monopoly is ‘bad’ and (p)
  competition is ‘optimal’ anything increasing market power
  is suspect and anything that increases competition is good.
• Thus is it that in some countries ‘monopoly’ is often
  thought to become a problem when a dominant firm has
  25/30% of a relevant market. We will see later under
  oligopoly theory that what happens in between the extreme
  models is much more complicated than that.


                          industrypartsa/b                 15
           Allocative efficiency
• The key argument in theory. The traditional simple
  textbook comparison of ‘good’ competition against ‘bad’
  monopoly. Under a long list of strictly defined conditions
  (to be examined later) we get:
• P > MC,
• Lower output produced, (compared to pc)
• Private super-normal profits (which is the incentive), and
• There arises a net or ‘deadweight’ loss of social welfare
  measured in terms of consumer surplus and called the
  Harberger triangle. See diag for details of these effects.

                          industrypartsa/b                 16
             Harberger triangle?
• After Arnold Harberger, a Chicago economist.
• Who in fact was critical of mainstream m theory and
  developed his famous triangle idea as a tool for identifying
  and estimating the size of the ‘harm’ from monopoly. We
  discuss later, under evidence, his initial finding which was
  that these losses were in fact rather trivial! And of course
  the many follow up studies which have supported or
  sought to challenge this initial finding.
• This is how economics works: idea, challenge, response,
  improved understanding.

                          industrypartsa/b                   17
 Monopoly and alloc. efficiency
• Diagram one (at lecture)




                   industrypartsa/b   18
      Organisational efficiency
• Idea here is that the absence of competitive
  pressures causes employees to slacken off their
  pursuit of cost efficiency. Thus employees indulge
  in effort relaxation, excessive expenses, big
  offices, lots of personal assistants, etc.
• Which causes overall firm cost levels to rise and
  exacerbates the impact of market power.
• Redraw diagram one and allow for higher level of
  costs, check outcome. How much worse is it?
• Commonly called ‘X’ efficiency after Leibenstein
  (Harvard) who coined the term
                      industrypartsa/b             19
        Organisational effic
• Diagram two




                industrypartsa/b   20
                            But
• Owners/ managers can in principle invest in greater effort
  to control organisational inefficiency and keep costs under
  control. Monitoring and enforcement efforts. Carrots like
  bonuses, sticks like foremen/ supervisors.
• But to the extent that these extra efforts cost more than
  under comp conditions then these costs can be seen as a
  resource ‘waste’ of monopoly. So even if a monopolist
  ‘looks’ reasonably efficient there may still be harmful
  consequences because of the extra efforts needed to
  achieve this outcome.
• Competition is being seen here as a cheaper device for
  generating discipline and promoting organisational
  efficiency.

                          industrypartsa/b                  21
 Dynamic efficiency (innovation)
• It is argued that competition not only forces firms to be
  cost ‘efficient’, it also forces them to be innovative, to be
  dynamically eff, if they wish to maintain their
  competitiveness or to escape from the pressures of comp
  markets and earn some ‘above normal’ profits.
• Under mon it is argued that the incentive to innovate is
  inevitably reduced. The mon already earns nice profits and
  this implies a naturally lesser incentive to innovate. (The
  profits of innovation less current profits basically). But
  NB the mon still has an incentive to innovate.


                          industrypartsa/b                   22
                    Arrow’s model
• There is an influential simple formal model which purportedly
  demonstrates this (intuitive?) result, called the Arrow model (after
  Kenneth Arrow). It is in the textbook (eg George) along with the long
  debate it ignited.
• The model is arguably a bit naïve (even George says it ‘strains
  credulity’) because it examines only the motivation of comp firms to
  adopt a new idea (rather than to seek it out in the first place) and so
  ignores the issue of the ability to undertake investment in R&D and
  innovation. Which may be even more important. We examine the
  issue more fully later on.
• NB I say arguably naïve, in view of the fact that Arrow won his Nobel
  prize for ideas like this! Respect!



                               industrypartsa/b                        23
               A paradox?
• Also, is there a paradox or a puzzle here?
• Competition creates incentives for
  innovation (so it is argued) often because it
  offers the prospect of monopoly profits! ie
  it offers an escape from competition. But if
  mon is harmful, couldn’t the competitive
  incentive to seek one be seen as harmful or
  wasteful? (see the Posner bit later)
                    industrypartsa/b              24
  Monopoly and product quality
• Argument (*more advanced*) that monopoly will
  tend to harm product quality, since firm has less
  incentive to promote the socially optimal level of
  product quality.
• Quality choice for the profit seeking monopolist
  will lead to an outcome where marginal cost of
  improving quality is equated with the marginal
  revenue from the provision of higher quality.
• As long as producing better quality is privately
  profitable it gets produced. But ….
                      industrypartsa/b             25
       Never mind the quality..
• But it is argued that the production of quality by
  the mon will be socially sub optimal. The socially
  optimal level of quality is at the point where the
  marginal social cost of producing quality equals
  the social marginal benefit of quality (as measured
  by willingness to pay, or price) which would be
  chosen say by a ‘benign’ ‘socialist’ monopolist
  (who exists in the textbook only).
• What is not clear however is whether private profit
  seeking competitive firms will produce the
  optimal quality outcome either.
                      industrypartsa/b             26
              Quality diagram
• Diagram 3

  Value of
  increases
  in
  quality




                                      Quality
                   industrypartsa/b             27
                Quality range
• It is argued further that a comp market will
  encourage a full range of quality, say from cheery
  but cheap at the bottom to exquisite but expensive
  at the top as competitive firms seek to fill the
  available market space.
• Whilst the monopoly will not provide a full range
  of offerings. It will produce enough at the top of
  the range but not at the bottom. The logic is it will
  seek to push more consumers ‘up market’ and thus
  wish to reduce the possibility of consumers buying
  at the lower end.
                       industrypartsa/b              28
            Is this suspicious?
• If a ‘comp’ firm fills each quality space available
  wouldn’t it then have a monopoly for producing
  that quality of product? Paradox?
• Textbooks use airlines for example, arguing that
  the difference between 1st class, and no class is an
  example of the issue. But how would competition
  (or a benign monopolist) work here? A first class
  flight only, a second class, and so on?

                       industrypartsa/b              29
            Posner’s extension
• Richard Posner argues that since monopoly is
  valuable competing firms will invest resources in
  searching for monopoly situations. (Also called
  rent seeking in some texts). Indeed you could say
  that competition is often the search for monopoly.
• Thus firms may invest in efforts to encourage gov
  to regulate competition (in airlines or banking), to
  restrict imports, to provide lengthy patent rights,
• And invest in R&D, advertising, acquire
  competitors, etc to win and maintain m power.

                       industrypartsa/b              30
                 Posner cont.
• How much will firms invest in the search for mp?
• Posner argues that firms will invest (in total) as
  much as the expected (capitalised) mon profits!
  (It’s a bit like a lottery game)
• Hence he suggests that this competition to
  become the monopolist is potentially just as
  socially ‘wasteful’ as having a monopoly so that
  the ‘costs’ of monopoly are arguably much greater
  than Harberger had originally suggested. It is
  Harberger triangle plus the private profit rectangle
  now.
                       industrypartsa/b              31
               Posner cont.
• Why? Because although the winner
  appropriates some nice juicy profits after
  paying of its costs, if you net out the costs
  to society of the various efforts that
  everyone else put in to winning then overall
  we are no better off in total! And the efforts
  are measured by the expected profits of
  winning.
                    industrypartsa/b           32
           Why like a lottery?
• Cause in total we all subscribe a lot more to the
  lottery than in total we can expect to win back!
• In fact each week we (in total) get back in prizes
  only half of what we pay for the tickets we buy!
• In this sense competition to win big prizes leads us
  to considerably oversubscribe (or over-invest)
  cause we rate our own chances of winning too
  highly (we behave irrationally). And this is
  potentially ‘inefficient’ or wasteful socially with
  respect to say R&D competition.
                      industrypartsa/b              33
• But this suggests that competition is the problem not
  monopoly and where does this logic lead? Publicly owned
  monopolies perhaps (the old LSE/ labour view)?
• It is indeed possible sometimes to see competition in a not
  so benign light. For example choice can be nice but it can
  become confusing not to say overwhelming. Been to
  Comet to buy a TV recently? Indeed competition can be a
  nuisance sometimes. Buses clogging the streets. Crowded
  airports. Double glazing salesmen phoning you.
  Newspapers with more adverts than news. TV advertising.
  Who needs it?
• Or might it be poss to distinguish ‘good’ (socially
  beneficial) competitive efforts from the not so good?


                          industrypartsa/b                  34
        Good v bad competition?
• Eg advertising is a comp weapon. If adv provides us with
  useful information it is valuable (efficient) socially but if it
  is mostly persuasive (encouraging brand jumping a la
  Coke/Pepsi) or builds entry barriers it is arguably not so
  good socially. Gets a bit difficult however.
• Who is to judge what is useful info and what is ‘harmful’
  persuasion? Maybe we enjoy being persuaded? And
  herein lies scope for quite different interpretations of the
  relation between market profitability and firm behaviour.
  The mainstream ‘harmful’ view that any above competitive
  level profits is due to ‘m power’, and the more benign
  competitive advantage view that it is due to superior
  capabilities and competencies to be considered later.

                            industrypartsa/b                    35
                Posner’s analogy
• Is along the lines that the true economic cost of crime is
  not measured by the goods stolen but include the cost of
  resources devoted to crime and its prevention. Which may
  be reasonable.
• But the analogy of efforts to beat the competition with
  criminal activity may be less reasonable. To say that
  efforts to build a brand or to innovate are anti-social in the
  way that bank robbery is seems to be stretching it a bit.
  Even lobbyists are not necessarily anti-social. There is
  such a thing as unfair foreign competition or unfair
  infringements of property rights and it is legitimate to
  complain about them.

                           industrypartsa/b                    36
              Call that a case?
• So that’s the essence of the ‘harmful’ case.
  Question is, how good a case is it? Is it as strong
  as mainstream textbooks suggest? How good is
  the empirical and case evidence on these things?
  Is there another more benign way of looking at
  firm behaviour and ‘excess’ profits?
• This is what we seek to consider next.



                       industrypartsa/b             37
   Part B. Debating the foundations
• A closer look at the foundations/ assumptions of
  the mainstream view (see any standard chapter on
  monopoly model). Aim here is to show that the
  standard results depend on a number of arguably
  extreme and possibly questionable assumptions.
• NB not aiming here to show m power is actually
  good for us, simply to suggest that it is not so easy
  to demonstrate convincingly that it is harmful in
  practice.
• Assumptions (1,2,…10) examined in turn.
                       industrypartsa/b               38
   1. Only one firm in the market
• Therefore no possibility of rivalry, no interdependence, of
  any sort. Firm is a price maker pure and simple.
• Because once any rivalry exists (as oligopoly or even
  fringe competition) the results get harder to predict as we
  see later. But one result is for sure: the social ‘harm’ of m
  power declines depending on the precise characteristics of
  the oligopoly in question. A key issue becomes the
  possibility of sustainable collusion which as we will see
  later is harder than it seems.
• NB also: empirically speaking absolute 100% mon is not
  common, except when granted by the state! Dominance is
  more common (big businesses with substantial m shares,
  say 50+ %) but that’s a different game!
                           industrypartsa/b                   39
         2. No ‘close’ substitutes
• For the monopolists product/ service.
• Because if there are, the (harmful) power to raise prices
  above marginal costs diminishes.
• The availability of subs affects the position and elasticity
  of the market demand function. And elasticity is a crucial
  determinant of the ‘harmfulness’ of monopoly result. It
  enters into calculations of the size of the Harberger triangle
  (see evidence part).
• For example there is only one Euro-tunnel but the subs
  (ferries, planes) seem to be close enough to constrain it
  quite effectively. In fact it loses lots of money! And so do
  some of the substitutes!

                           industrypartsa/b                   40
  Elasticity of demand: significance
• Recall the definition and significance from earlier classes.
  And the precise relation between elasticity and total and
  marginal revenue. NB also the profit seeking monopolist
  always prices where elasticity exceed one. Why?
• Note that since the m price is where demand is ‘elastic’
  there must be substitutes available to produce that result.
• Note also how the size of elasticity (e) (2,3,4,5) determines
  the exact divergence of monopoly price from cost.
• Look up the ‘Lerner index’ which formally expresses this
  relationship. As e increases the price-cost margin falls.


                          industrypartsa/b                   41
        Substitutes and containers
• Lets say there was one firm producing all the glass bottles, one
  producing plastic, one doing aluminium cans, one doing tetra pak
  cartons etc. Does this mean four ‘harmful’ monopolies or a
  differentiated competitive oligopoly market?
• Are Coca Cola and Pepsi monopolists or do they produce very close
  substitutes? What about CC and Perrier? Or CC and coffee?
• Point is, it is a matter of degree. Ultimately everything is competing
  with everything else for the consumer’s dollars (and other resources).
  Drawing neat boundaries and calling them ‘markets’ is more difficult
  than it appears. What is the software market? The drinks market?
• Although identifying industry bounds is easier cause this is defined in
  terms of production technology (glass bottles and aluminium cans) not
  competing substitutes.


                               industrypartsa/b                         42
        Monopolistic competition
• In fact the so called mon comp model is often construed as harmful as
  well. This is a model with all the characteristics of perfect comp apart
  from homogeneous products. It allows for the existence of slightly
  varied or differentiated products which are very close, but not perfect,
  substitutes. So there may be a lot of competition, but it is amongst
  small ‘monopolies’. For ex, there are lots of cafes in Paris but some
  are nearer your hotel than others and none of them are exactly the
  same. This is thought to be harmful because in equilibrium prices are
  shown to diverge from marginal costs. So the result isn’t quite that of
  the ‘perfect’ competition model where price equals m costs.
• But so what? If people like ‘variety’, if they value distinctiveness, and
  are prepared to pay slightly higher than ‘perfectly’ competitive prices,
  who are we to call it harmful? Would we be better off if every café
  was exactly the same?
                                industrypartsa/b                         43
   How extreme an assumption?
• In the SR perhaps not so extreme.
• But in the longer run it is extreme for the simple
  reason that the existence of mon profits will
  encourage the development of closer substitutes.
  So the question for the monopolist is how long
  will this take? (And what can it do to slow it
  down?) If it seems technologically unlikely the
  mon can rest easy. But technology has a way of
  surprising us. Need I mention the internet?
• This is important because harmfulness is related to
  longevity. Short lived mons are not a big problem.
                      industrypartsa/b              44
  ‘New economy’ critique of MP
• A group of authors/consultants argue that the nature of
  new economy (1990’s style) makes market power less
  sustainable than ever.
• Consultants such as McKinsey (creative destruction), PWC
  (continuous transformation), and authors such as Prahalad-
  Hamel (competing for the future), D’Aveni (hyper-
  competition), Wood (complexity) and Brown-Eisenhardt
  (competing on the edge) and Mendelson (organisation IQ)
  all argue basically that profits are increasingly transitory,
  temporary, short lived, and impossible to sustain.
• A composite view of these authors is next.

                          industrypartsa/b                   45
      Comp in the new economy
• All profits are transitory. They always attracts competition
  and get squeezed. Success (?) generally comes from attack
  not defence. No business can stand still. Not even a
  Microsoft. Success needs to be constantly renewed by
  continued investment efforts. This depends on:
• Creativity, innovation, newness, surprise, initiative,
  flexibility, speed of reaction, decisiveness, opportunism,
  anticipation, reinvention, organisational intelligence,
  identifying and exploiting the right options, energising
  the business.
• That is on developing and using competitive capabilities to
  produce a competitive advantage, not on static mon power.

                          industrypartsa/b                  46
                 Note on semantics
• Industry is an unsatisfactory term.
• It is ok for some purposes to talk of the hotel industry, the publishing
  industry, the auto industry. But it is imprecise.
• Competition is about specific markets not industries. Think of
  industries such as hotel, publishing, auto, education, finance,
  pharmaceuticals? In hotels we have luxury hotels, mid range hotels,
  cheap and cheerful, backpackers. (US/EC/SEA etc) In drugs, there is
  no single market, but dozens of distinctive markets relating to
  particular problems.
• Point? Competition is about reasonably well defined distinctive
  markets for particular customer segments in particular places.
• In autos it is true in general that Ford ‘competes’ with VW. But even
  here the important action is in well defined market segments (small
  cars say) in particular areas (UK).

                                industrypartsa/b                             47
           Defining the market
• Anti-trust authorities need to be able to define
  relevant markets and this can be difficult.
  Essentially what they wish to identify is a situation
  in which a hypothetical monopolist could raise
  prices significantly and sustainably (say over 5%
  for a year). To do this they need to consider the
  demand side, supply side and geography. SEE
  also L&W on this, chap 6.2


                       industrypartsa/b              48
• On demand side they would consider the extent to
  which consumers perceive products to be
  substitutes. If oranges are considered a very good
  sub for apples but not for bananas then o/a are part
  of the same market but bananas are not
• On supply side they would consider how easy it
  might be for producers to switch production
  between goods. For example if a cola bottler can
  switch to bottling water with ease but not milk
  then the first two are closer subs.
• On geography they would consider whether a
  hypothetical monopolist could sustain a price rise
  in region x. If so, that is the relevant market, if
  not, define a bigger region until the answer is yes.
                       industrypartsa/b              49
                      NB
• A monopolist will set price where demand
  is elastic, where subs begin to make their
  presence felt. So the existence of subs for a
  mon market it is argued doesn’t per se
  indicate there is enough potential
  competition at present. The question should
  be, ‘would there be any serious subs at the
  comp price in the relevant market’? If not,
  then the market is effectively monopolised.
                    industrypartsa/b          50
                 In practice
• Needless to say in practice defining the relevant
  market is one of the most contentious areas of
  comp policy. The authorities will tend to seek a
  narrower definition than producers.
• Take newspapers. What market is the Sun part of?
  Tabloids only, or all national newspapers and
  news magazines? What about free newspapers
  and local newspapers? What about TV news
  programmes? And nowadays the internet? Plenty
  of scope for arguing.
• Try the market for alcoholic beverages.
                     industrypartsa/b             51
           3. Entry is blocked
• Potential rivals find it unprofitable to enter the
  market to take on the profitable incumbent so no
  need for incumbent to make allowances for this
  possibility despite there being incentives to enter,
  in the form of the profit opportunities.
• Again possibly an extreme assumption in the long
  run although it is true that incumbents have
  incentives to actively invest in the creation of
  entry barriers to seek actively to discourage rivals
  (more details on this later under oligopoly).

                       industrypartsa/b              52
            Extreme? : Consider
• The many markets that had very powerful incumbents and
  apparently very high barriers to entry that eventually
  succumbed to successful entrants.
• The US auto industry pre Japanese invasion, IBM before
  the PC revolution, the UK steel industry, the telecoms
  market, Xerox, Dunlop, Woolworths, etc
• All profits are transitory. See slides above on this
• Same idea re barriers this time. Barriers to entry not what
  they were. Many towns had only one or two booksellers,
  banks, record stores. And along comes Amazon and co
  and jumps the barriers.

                          industrypartsa/b                  53
      The cherry picker strategy
• Entrants need not, and generally do not, take on the
  dominant incumbent directly, ie do not seek to replicate the
  dominant firms business model.
• There is the possibility of the ‘cherry picking’ strategy,
  where entrants seek to identify particular segments of the
  market where they might prosper. Where perhaps
  entrepreneurial alertness/ flexibility overcomes the
  advantages of size.
• For example when postal services have been liberalised
  new entrants are often accused of cherry picking, ie
  focusing on the most attractive bits of the market like big
  cities, or business mail, or parcel services.
• And think how the bottled water market has developed.

                          industrypartsa/b                  54
           Consider re barriers
• The question of harmfulness. If mon is harmful
  by implication so are the barriers protecting it.
• But can all ‘so-called’ barriers really be harmful?
• For example a standard ‘barrier’ identified in all
  the textbooks is the ‘absolute cost’ barrier. These
  are said to arise from first-mover advantages
  based on scale or the ‘aggressive’ chase down the
  learning/ experience curve or reputation etc.
• But why is this harmful? What is meant? Can
  there be competition without aggression, without
  someone trying to be a winner?
                       industrypartsa/b             55
• This situation described could be seen as the
  natural result of one business taking the risks
  (making commitments) involved in developing a
  new product and moving first to develop the
  market. The reward is possibly an early cost
  advantage but remember in fact not all first
  movers become long term winners (Apple!). So
  could the ‘advantage’ be seen as a reward for the
  socially useful risk of pioneering.
• Also network effects (see next slide), create
  barriers which protect some companies but this
  seems to result from consumer choice. This might
  be tough luck on the competition but is it harmful?
                      industrypartsa/b              56
               Network effects
• A factor encouraging dominance but deriving from the
  demand side. Idea is that for some products/ services, the
  value of ownership/use increases the more owners/users
  there are. Because of the benefits of the growing network
  (installed base) of users.
• For most products this doesn’t apply. VW cars don’t
  become more valuable to you as more people acquire
  them. Au contraire.
• But for some things it does. Software for example.
  Microsoft arguably owes is success to this effect.
  Consumers value compatibility/ transferability and so we
  have all tended to adopt the same OS and related software.
  Could have been Apple, or IBM. A dominant supplier was
  likely to emerge here.
                         industrypartsa/b                 57
              Strategic barriers?
• However deliberately created ‘strategic barriers’ may be
  more problematic.
• Product differentiation, advertising and brand names,
  product proliferation, predatory pricing are seen by some
  as deliberate ‘strategic’ actions aimed at protecting a
  business from entrants. But is this always the case?
• Take advertising. Admittedly some may indeed be
  ‘strategic’. But adv can also be socially valuable because
  consumers value information about product specs,
  qualities, options. How else can we learn about what’s
  available? Or product proliferation in cereals/ toiletries etc
  which could be seen as improving consumer choice.

                           industrypartsa/b                   58
          Two ways of seeing
• It seems there are (at least) two ways of seeing
  firm behaviour. One looks at it as largely about
  on going competitive efforts to get and stay ahead,
  a treadmill, the other sees most firm actions as
  attempts to ‘destroy’ competition with negative
  social effects. Thus even if a monopoly has ‘low’
  prices because it is worried about the threat of
  entry etc it can be attacked for ‘predatory’
  behaviour (as Microsoft has been).
• Maybe the competitive process is inherently
  double edged. Some see a half filled glass, others
  a half empty glass.
                      industrypartsa/b              59
        4. Profit maximisation
• Mon model assumes p max. Extreme? Possibly,
  think back to the possibility that for various
  reasons some firms pursue objectives other than
  profit such as size/ and growth (Marris).
• If so, this would lead away from the ‘harmful’
  outcome nearer to the competitive outcomes for
  price/ output.
• Eg the Baumol (profit constrained sales
  maximisation) model (see George) must lead to
  lower prices and higher output.

                     industrypartsa/b               60
      5. No price discrimination
• Standard model assumes there is no price disc by
  the monopolist.
• First, consider the principle of p discrimination.
  Charging individual consumers (or groups of
  consumers) different prices according to their
  maximum ‘willingness’ to pay for the product.
• In the standard monopoly model (see fig) the
  initial monopoly profit rectangle is ‘captured’ or
  appropriated consumer surplus. But this leaves a
  lot of consumer surplus unexploited. Price disc is
  an attempt to exploit it more fully.
                       industrypartsa/b                61
    Diagram 4 : Price discrimination
    Explanation in lecture

P




    industrypartsa/b         Q         62
         Degrees of price disc
• 1st degree: where you seek to extract/ appropriate
  the whole of the available consumer surplus
• 2nd degree: where consumers pay a different price
  according to the quantity they choose to buy
  (quantity discounts, multi packs)
• 3rd degree: customers are segmented by type (age/
  sex/location/…) and charged according to the
  segments willingness to pay.
• See a good text such as George/ Church et al for
  details of these and examples
                      industrypartsa/b             63
      The paradox of price disc
• If a monopolist can achieve p disc a potentially
  paradoxical result arises. The social harm of
  monopoly falls. Paradox because a price disc mon
  is more powerful than before but less ‘harmful’.
• Why? Because it gets nearer to the desired
  allocative efficiency (ie competitive) output!
• Of course the distribution of income outcome
  might not be acceptable but that is not an
  efficiency issue, it is an ethical/ political one, an
  issue of judgement which economists are no better
  at deciding than plumbers or dentists.
                       industrypartsa/b              64
         However re price disc
• We have to note that whilst all mons would seek
  to use p disc it is not always possible to do it in
  practice. And it is not a costless exercise. There
  fore not all will actually be observed doing it.
• Difficult?: first because of information problems
  (about consumer willingness to pay) and second
  because of arbitrage problems (clever
  entrepreneurs).
• So should competition policy encourage it or
  discourage it?

                       industrypartsa/b                 65
          6. Cost differentials
• The standard mon model assumes that the mon
  and the comp industry have the same level of
  costs. No economies of scale exist. The LRAC
  curve is flat.
• But this is strange. Because a major reason for
  mon will be economies of scale (and scope)
  benefiting large-scale operations (car assembly or
  supermarkets say), so the mon generally will have
  lower costs. So is the standard comparison fair?

                      industrypartsa/b             66
                     Maybe not
• Oliver Williamson looked at the standard model, and drew
  in a lower cost line to allow for scale benefits (a declining
  long run average costs in the textbook language).
• Consider as he did what would happen to prices now, and
  the deadweight ‘loss’ of monopoly.
• He used some simple arithmetic concerning demand and
  cost parameters to suggest the following conclusion.
• ‘Relatively small cost reductions from beneficial scale
  effects (say 10%) would outweigh allocative losses due
  to full market power pricing’
• If scale effects are large there may even be net gains from
  monopoly rather than Harberger type losses.

                           industrypartsa/b                   67
        Williamson’s diagram
• D 5 in the lecture




                       industrypartsa/b   68
             On the other hand
• Remember organisational or x efficiency? If m
  power creates opportunities to slacken off, costs
  may creep upwards. And so offset some of this
  good cost result.
• See this by doing the W diag again but factoring in
  rising costs due to cost creep. If these outweigh
  the benefits of scale then you are back to the
  original Harberger loss or worse.
• However note that all is not lost! The ‘slackers’
  get utility from slacking/ big offices etc and this is
  in a way a ‘redistribution’ of total market surplus
  not a total (or deadweight) loss.
                       industrypartsa/b               69
                  X-tensions
• What if the rise in costs affects Fixed Costs but
  not Marginal Costs? That is inefficiency strikes at
  overheads and the like, not at incremental
  production costs. A plausible scenario.
• Then the equilibrium price/ output doesn’t actually
  change, and the cost increase is pure transfer
  (from owners to employees). The social loss of
  monopoly isn’t increased.


                      industrypartsa/b             70
    An ‘x’ efficiency conundrum
• Under highly comp conditions would employees/
  managers of all firms really feel threatened by the loss of
  employment and work at peak levels?
• If there is full emp in the competitive economy then the
  loss of job isn’t much of a threat! Redundant resources get
  picked up elsewhere! So will there really be universal x
  efficiency in the competitive economy? Good question.
• Plus highly comp markets can be harsh and un
  compromising and breed social resentment and defensive
  reactions etc (read all about it in Zola, Dickens, Dos Passos
  et al), and so damage social efficiency! What is the anti
  globalisation movement on about? Is efficiency produced
  by implied threat necessarily desirable?
                          industrypartsa/b                   71
           7. The Coase critique
• Ronald Coase argued that the standard m model makes no
  allowance for the role of product durability (use over
  multiple periods). Some products are bought for
  immediate consumption but many are not (houses for ex)
• The mon in general faces a credibility problem in getting
  the mon price to stick. It has in a way an incentive to cheat
  on its own monopoly price. Because once it successfully
  sells the m quantity at the m price, it could in principle
  earn even more by then undercutting this previous price.
• This is not a problem in a single period textbook model,
  cause then there is no next period in which to cheat
  yourself! But what if we consider the problem over time,
  with multiple discrete selling periods?
                          industrypartsa/b                   72
                  Coase cont.
• With a multi-period setting product durability
  becomes an issue. Why?
• Because in the first period the m sells the m
  quantity to those with the highest willingness to
  pay for those units of output.
• But these folk still have the product in the next
  period (or sell it second hand if they lose interest),
  and those still ‘in’ the market by definition will
  only buy at a lower price. So the m will need to
  lower prices (cheat itself) in period two.
• BUT
                        industrypartsa/b               73
                  Coase cont.
• If the m is likely to cut prices in the second period
  who would buy in the first period when they can
  hang on a bit for a bargain? Will some/ a lot of
  people not postpone buying? Would we not be
  influenced by the possibility of falling prices to
  wait? Of course it would depend on how
  ‘impatient’ consumers were. Or technically, by
  how much we ‘discount’ the future.
• Some people do time purchases of consumer
  durables (autos, PCs, TVs) quite carefully (we
  wait for Christmas sales for example!)
                       industrypartsa/b               74
              Coase concluded
• That the need to lower prices over time (inter-
  temporal price discrimination if you like) would
  reduce m pricing power. Reduce the m ability to
  capture m profits. Depending on how long a
  period is. A day, a week, a year. And of course on
  consumer patience.
• So a mon in this situation can only seek to ensure
  max profits now if it can commit itself to not
  cutting prices later. Or if it leases rather than sells
  its products outright (as Xerox, IBM, et al used to
  do). See if you can figure out why.
                        industrypartsa/b               75
                  Pacman* defence
• However as you will expect there is a counter argument. Durability
  might work to the advantage of the m instead!
• The idea is now that the m acts tough and tells consumers it will set the
  max price it can get for each unit (say houses) and wait until it gets a
  taker. Then it will set a slightly lower price and wait until that unit
  sells and so on. So it becomes a battle of wills, and if the m wins it
  extracts lots of lovely consumer surplus.
• Could this work? Depends on things such as how long the m can
  credibly afford to hold rather than sell its products. And consumer
  patience. Think of this the next time you by a new CD or a DVD.
• * Pacman implies a strategy of ‘turning the tables’ on an opponent. Eg
  an intended takeover target suddenly makes a bid for a putative
  acquirer instead.


                               industrypartsa/b                          76
      8. Countervailing power
• Standard m model assumes no countervailing
  power on the other side of the market. ie buyers
  are numerous and dispersed and can’t argue back.
  Coalition problems.
• But what if they are not? What if the buyers are
  few, or even only one (a monopsonist). It happens.
  Supermarkets like Wal Mart and Tesco can take
  on even powerful suppliers like Heinz, Coca Cola,
  or L’Oreal.


                      industrypartsa/b            77
• In this case the monopolist’s profits will be reduced
  because it now faces more powerful buyers who can
  bargain rather than ‘take it or leave it’.
• The mon seller still wants to set the m price, but the buyers
  demand a lower price (which max their profits) because it
  or they have monopsony power (buying power)
• Now in fact there is no easy predictable (ie equilibrium)
  outcome because it will depend on relative bargaining
  power and credibility. The m wants to set the high m price,
  the buyers demand the low monopsony price (see textbook
  on how difficult it becomes to find the outcome now)
• This redistributes potential mon profit (consumer surplus)
  back to the buyer side.

                          industrypartsa/b                   78
                Balance of power?
• Switching costs. If the buyer becomes familiar with particular
  suppliers this may raise costs in switching to another.
• Information costs. Often consumers find it expensive to be properly
  informed. Car servicing, medicines, financial services, software. Power
  is with the best informed.
• Economics of DIY. If the customer could DIY this constrains
  suppliers. If suppliers could integrate forward it constrains buyers.
• Reputation. Being a Toyota supplier is a big deal, powerful suppliers
  prepared to ‘pay’ for that. Buying Intel chips is a safe bet, customers
  like Dell and Compaq pay for that. Airlines will only use a big name
  engine supplier like RR. Harvard is the place for an MBA. Msoft for
  software writers.
• The customer’s customer. When your customer sells on you might
  be able to influence its customers. Does Dell install Microsoft/ use
  Intel because it likes them best or because it matters to customers who
  will pay a premium for these things?

                               industrypartsa/b                        79
             Another paradox
• Arises in this situation.
• It can be shown (bilateral monopoly case) that
  vertical integration between two monopolies (one
  buying what the other sells, say a generator and a
  distributor of electricity) can produce social
  benefits. Such as from reducing bargaining costs.
• Paradox here being that two mons are therefore
  ‘better’ than one.

                      industrypartsa/b             80
         9. Mon and innovation
• Does mon power really harm innovation (dynamic
  effic) as Arrow’s famous model suggests?
• Recall first that this concerns the strength of the
  incentive to innovate, ie it is about relative desire
  to use or adopt a new idea (but not to look for it in
  the first place!) It is intuitively appealing, but still
  might be wrong-headed. Plus….
• It says nothing about relative ability to innovate!
  Which may well be more important in practice.
• Maybe why George text says the model ‘strains
  credulity’. Lets investigate a bit further.
                        industrypartsa/b                 81
Comp for the market v comp in the market
• An important distinction to keep in mind.
• What is the key issue in R&D/ innovation?
• Is it driven by competition already in a market, or by
  competition for a market (which may not even exist yet)?
• Point? There may be a lack of competition IN a particular
  market (telecoms 20 years ago) but that doesn’t stop
  competition FOR that market by others investing in R&D.
• In pharmaceuticals patent protection often diminishes
  competition in the market for a decade or so, but it cannot
  prevent competition FOR the market continuing. Other
  firms can (and do) keep investing in R&D and if one
  comes up with something better, can then compete in the
  market or itself become the dominant supplier.
                          industrypartsa/b                  82
• If we look at competition in innovative industries
  we often see this. Several businesses or
  entrepreneurs seek new products/ technologies.
  Winning is nice for the winner, but not a guarantee
  of sustainable dominance. The race can continue.
  Successful innovators can seek to replace the
  incumbent.
• Remember the words of Intel man, ‘only the
  paranoid survive’. Meaning no matter how
  dominant you are today you can disappear
  tomorrow.
• So should we worry a lot about the state of
  competition in a particular market if there can be
  competition for it?
                      industrypartsa/b             83
                 Value innovators
• Innovators focus on creating new markets, not on beating up on the
  competition. Successful companies do not focus on the competition
  but on making competitors irrelevant by providing buyers with a
  quantum leap in value.
• Value innovators use the consumer as the reference point not the
  competition. Innovation is driven not by the technology but by
  customer value. VI ask: are we offering consumers radically superior
  value? Are our prices accessible to the mass of buyers in the market?
• Examples: Wal Mart, Ikea, CNN, SAP, Starbucks.
• Emphasis of these companies is not on patenting ideas but on the
  combination and arrangement of elements (bundles) attractive to
  consumers. And hard for competitors to match. Harvard BR, 2000,
  Sloan MR 1999


                              industrypartsa/b                        84
Some characteristics of investment in R&D
• 1. It is very expensive and time consuming needing specialised
  resources and facilities. Think of pharmaceuticals or electronics.
• 2. It is very risky: there is a lot of uncertainty involved, will you find
  something, will it sell, will you recover dev costs?
• 3. Costs involved are open ended (once you start its hard to stop!) and
  largely sunk.
• 3. Investment is hard to evaluate, (what is the NPV?) so raising
  finance is a problem. The bankers find it hard to fathom.
• 4. The output is knowledge, which is hard to protect, so hard to
  capture all the rewards if successful. Some, or a lot, will leak out.
  Despite patents. You might do the work whilst others reap the rewards.
• 5. It is difficult/ and so costly to organise and manage effectively
  within the organisation (monitoring and controlling the process)
• 6. There may be significant economies of scale/ scope involved.


                                industrypartsa/b                          85
              Developing drugs
• Almost half of the profits of major drug businesses such as
  GSKB (until recently this was four different firms) go into
  development (£2 billion)! Indeed this has been the driving
  force in the recent development of such giants. To ensure a
  blockbuster every now and again a company has to bring
  some new products to the market every year. Only a very
  big business can achieve this.
• You must have a solid ‘portfolio’ of new drugs in the R&D
  pipeline many of which are unlikely to make it. Average
  R&D lead time is 12 years and costs £200m. The
  minimum annual spend to stay in the race is put at around
  $2 billion!
• Sources: Deutsche Bank/ Lazard Freres.

                         industrypartsa/b                  86
   Markets and R&D/ innovation
• What is likely to promote the ‘best’ level of investment in
  R&D socially speaking?
• Note immediately that competitive markets driven by the
  profit motive can’t produce the social optimal level
  anyway (where msc = msb), so it is about the choice
  between two structures (mon and comp) which are both
  imperfect. Why? Because:
• The social benefit of R&D exceeds the private (eg because
  of spillovers), and the social costs of R&D is less than the
  private (eg because of taxes). So society will favour more
  R&D than comp markets will promote.


                          industrypartsa/b                   87
            R&D competition
• First, it is possible that too much competition in
  searching FOR the next big winner could be
  wasteful cause it might lead to excessive spending
  (a la Posner). A lottery type effect (see earlier
  slide on this). The thought of a big prize can
  cause us to behave foolishly. The total amount
  spent approaches or possibly exceeds the prize to
  be won. Could competitive firms end up doing the
  same thing looking for winners? Drug companies
  for example. Would that be socially useful?

                      industrypartsa/b            88
• Second, possibly too much competition will
  reduce R&D because it reduces the ability to
  finance risky investments. Capital suppliers find it
  hard to figure the probabilities. And find it hard to
  monitor effort/ performance. Thus, R&D is in
  practice largely financed from business profits.
  But highly competitive markets don’t allow for
  above normal profits. So how can firms finance
  R&D? Some economists have argued that for this
  reason market power will encourage innovation
  rather than harm it.

                       industrypartsa/b              89
• Third, too much competition may reduce
  R&D efforts and innovation because of
  problems with appropriability of rewards.
  Even if you succeed how can you stop fast
  imitators? Look at Sony! At how quickly
  its innovations are copied. It has to run
  very fast to stay ahead. Will it get fed up?
  Monopolist presumably has less to worry
  about here so stronger incentives to spend.

                    industrypartsa/b             90
• Fourth: mon incentive to innovate may be stronger than
  Arrow allowed for because in practice it knows that if it
  doesn’t innovate its current profits can eventually be
  eroded by an innovating entrant. This is R&D as a
  protection policy. If the monopoly thinks forward it must
  see this. In fact it can be shown in principle that a
  monopolist has a greater incentive to innovate to sustain
  itself than a potential entrant has to innovate and then
  compete with the monopolist.
• Hence again the man who ran Intel, a firm with a lot of m
  power: ‘only the paranoid survive’. Or the boss of GE
  who urged his executives to ‘destroy the business’ before
  someone else did.

                         industrypartsa/b                     91
• Fifth, a monopolist may even over invest in
  R&D simply because it can afford to. It has
  the money to indulge itself and to make sure
  it stays ahead of the game. Managers
  especially may be prone to this because they
  gamble with someone else’s money. The
  shareholders bear the risks of failure,
  managers get the glory for success.
  Managers can lose a career to a successful
  entrant, shareholders just lose money.
                   industrypartsa/b         92
• Sixth, innovation might be best served by a
  moderate degree of competition amongst strong
  rivals rather than intense comp. Oligopolists as
  we see below soon learn that price competition is
  destructive all round and will try to cooperate.
  This possibly has the effect of deflecting
  competitive efforts to the less destructive
  innovation (or advertising) where firms can get an
  edge which is more difficult for others to quickly
  follow up.
                      industrypartsa/b             93
• Finally, too much competition might harm the realisation
  of significant economies of scale&scope in R&D process
• Scale as we have seen is likely to be vital when
  development costs are big. Dev costs are paid upfront and
  have to be amortised over future output. The bigger the
  better, because of the pricing implications of cost recovery.
  Small comp firms just couldn’t do it. (what about
  collaboration to overcome this disadvantage?)
• And scope? Portfolio effects exist. Pursuing just one idea
  is very risky! But having a portfolio of ideas on the go
  means things might balance out. Some you win many you
  lose. But a big winner compensates for all the losers. Like
  a share portfolio, the winners compensate for the duds.
  This makes money easier to raise in principle. (Although
  note, a financier could in theory invest in a portfolio of
  small business R&D).

                          industrypartsa/b                   94
    The Schumpeter hypothesis
• A combination of some of the above arguments
  was in fact first put forward in the 1940’s by
  Joseph Schumpeter and much of the subsequent
  debate in the area has referred back to his ideas
  (and of course Arrow’s).
• These were to the effect that technological
  dynamism was in fact best served by big business
  with a good degree of market power (not
  necessarily monopoly however). As we will
  discuss later these views have been the subject of
  much empirical research and testing.
                      industrypartsa/b                 95
 10. View of competitive process
• Finally, The mainstream textbook view of
  competition and the comp process is
  arguably very narrow. PC & MC models
  basically, with even the latter tagged
  harmful. But is that it really?
• There are other ways of looking at the
  world. Broader, more dynamic, more
  realistic, overlapping views of competitive
  process.
                   industrypartsa/b             96
The Austrian view of competition
• According to this school of thought the textbook focus on
  ‘industry’ structure is misguided. It is the FIRM alone that
  matters, because ‘industry’ structure is a consequence of
  how firms compete not vice versa
• Market structure is an outcome of competition between
  firms, the search for competitive advantage, not a
  determinant. It is endogenous not exogenous. Firm
  actions and relative success determines both market
  structure and average profitability. The idea that market
  structure drives profits is thus spurious. Back to this later
  under evidence. Firms are unique & heterogeneous. And
  everyone is competing with everyone else for
  resources/customers.
• See for ex Hill/Deedes, J of Management Studies, 1996
                          industrypartsa/b                   97
           Interdependence
• The two views are of course not mutually
  exclusive. Firm actions can obviously
  affect market structure outcomes, and
  market structures can influence firm
  actions. There is interdependence between
  the two rather than the one way causation of
  the textbook S-C-P model. This seems
  likely.
                   industrypartsa/b          98
 John Kay’s case for competition
• Is much better than standard textbook case.
• In ‘The truth about markets’ (2002) book Kay argues that the case is
  really about how competition encourages the variety of experiments or
  plurality of approaches and is ultimately more responsive to consumer
  needs. Monos finds it hard to promote plurality of thinking and are
  less responsive to needs. See esp his chap 30 on disciplined pluralism.
  Policy should promote pluralism not some idealised state of
  competition. Pluralism is about encouraging and making use of new
  info to innovate in value. So if one firm earns ‘excess’ profits it is not
  a matter of concern as long as others are at least allowed to seek to
  challenge it.




                                industrypartsa/b                          99
       Competition is a process
• Competition is a process (not an event) arising
  from the on-going desire of organisations to
  search for ways of creating and capturing value.
• Whenever one business identifies and exploits a
  profitable opportunity it demonstrates its potential
  to others who seek ways of grabbing a piece of the
  action.
• PC’s, memory chips, selling on the internet,
  mobile phones, budget airlines, ….
                       industrypartsa/b             100
      The nature of competition
• Firms compete in different ways, or different
  combinations of ways, which change over time.
• Price competition
• Marketing/ advertising/ differentiation
• Product development/ quality improvements
• Product range (esp retailing)
• Reputation
• Innovation
• Litigation

                     industrypartsa/b             101
    Creating ‘competitive advantage’
•   Cheaper (lower costs) producer: ?
•   Better (superior perceived quality): ?
•   Newer (more innovative/up to date/fashionable): ?
•   Faster (speed to market): ?
•   More desirable/ distinctive (successful branding):?
•   Better reputation: ?
•   First mover: ?
•   Provide your own examples of firms that compete
    successfully on this basis.
                        industrypartsa/b             102
           Competition processes
• Imitation/ replication: good ideas, products, services get copied/
  imitated rapidly(often even patents aren’t much of a protection), eg
  Amazon, Easy Jet….
• Commodification: once innovative products eventually tend towards
  standardised commodities, eg microprocessors, most pharmaceuticals,
  ball point pens….
• New entry: first mover profits are dissipated by attackers, new
  entrants, eg photo-copiers, mobile phones, ..And NB new entrants need
  not be ‘new’ businesses.
• Technological change: competition can appear from unexpected
  directions. On-line degrees, internet bookshops/ banks, e mail, ….
• Fragmentation: specialist firms begin to cherry pick the most
  valuable segments: postal services, consumer electronics, boutique
  hotels.

                              industrypartsa/b                      103
                    Processes cont.
• Deregulation/ liberalisation: established monopolistic positions
  (often granted by state fiat) are opened up, eg airlines, water, postal
  services, electricity, telecoms….
• Globalisation: increasing penetration of national markets by
  international firms: autos, telecoms, financial services, electricity.
• Information (and communication) costs: are falling as a result of
  technology. Increasing price visibility and value comparability. Look
  at car buying for example, or bookselling, or electrical goods, or travel.
• Integration: suppliers integrate forward (Msoft into game consoles),
  customers integrate backwards (Dell into producing peripherals?)
• Other factors at work: More demanding, better informed, consumers
  (What computer, What hi fi etc).



                                industrypartsa/b                         104
       Competition for the market
• Innovators focus on creating new markets, not on beating up on the
  competition. Successful companies do not focus on the competition
  but on making competitors irrelevant by providing buyers with a
  quantum leap in value.
• Value innovators use the consumer as the reference point not the
  competition. Innovation is driven not by the technology but by
  customer value.
• VI ask: are we offering consumers radically superior value? Are our
  prices accessible to the mass of buyers in the market?
• VI uses target pricing to build volume and target costing to ensure
  good margins.
• Examples: Wal Mart, Ikea, CNN, SAP, Starbucks.
• Emphasis of these companies is not on patenting ideas but on the
  combination and arrangement of elements (bundles) attractive to
  consumers. Harvard BR, 2000, Sloan MR 1999


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     Market space v market share
• Competition is now about max. your share of consumer
  spending (market space) not specific product market share.
• Seeking to ensure longevity (loyalty), depth, breadth, and
  diversity of spending.
• BP for example seeks to sell ‘energy solutions’ not just oil.
  Unilever no longer just sells cleaning products but markets
  cleaning services/solutions. Lego embraced the possibility
  of computer games which had threatened its traditional
  business. Virgin offers a comprehensive door to door
  service not just a flight. Ford is no longer just about
  ‘pushing the metal’ but total product/ service packages.
• Sloan management review, 2000

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           ‘Perfect’ competition
• Is really the antithesis of competition as we know it. So
  referring everything to the idealised model is misleading.
  Competition in practice IS about seeking advantage by
  methods such as product diff and development, innovation,
  quality improvements, ….not just price. Markets
  conforming to the idealised model are rare. A world like it
  would perhaps not be very perfect at all. In any case comp
  doesn’t have to conform to the perfect model to be
  beneficial. Otherwise capitalist economies wouldn’t be
  super-rich.


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          Sum up on m power
• So we have it. The textbook model of mon is
  based on a set of quite extreme, possibly dubious,
  assumptions which ‘strain credulity’ and which
  weaken the universality of the naïve ‘harmful’
  result. We do not seek to show m is good, just
  that it may not be, on balance, as ‘harmful’ as the
  mainstream two dimensional model suggests.
• But this is not end of story, next we should
  consider oligopoly markets, what happens
  between the two extreme models. Then of course
  look at the empirical evidence on these issues.
                       industrypartsa/b             108

				
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