Chapter 10

Process, Output, and Strategy:

Pure and Monopolistic Competition
 COMPETITIVE STRATEGY

The Three
Under the 3essence
rd essence of Competitive
of Competitive Strategy
Strategy are:
• Generic Types of Strategies - Strategic thinking initially focuses on industry
analysis—that is, identifying
1. Resource-based industries
capabilities in which itstrategy
– Competitive would beanalyzes
attractivehowto do
the
business.
firm can secure differential access to key resources like patents or
• Product
distributions channels.
differentiation strategy - usually involves competing on capabilities,
brand naming,Process
2. Business or product endorsements.
- competitive strategy designs business processes that
• Cost-based
are difficult
strategyto imitate and capable
- a business-level of creating
strategy unique
that relies upon value
low-costfor the
target customers.
operations, marketing, or distribution.
3. Adaptivetechnology
• Information Innovationstrategy
- competitive strategy strategy
- a business-level providesthat
a road
reliesmap
on ITfor
sustaining a firm’s profitability, principally through innovation.
capabilities.
.
 THE RELEVANT MARKET CONCEPT

• Relevant Market – a group of firms that interact with each other

in a buyer-seller relationship.
Concentrated market
relevant market with a majority of total sales occurring in
the largest four firms.
Fragmented
a relevant market whose market shares are uniformly small.
Consolidated
a relevant market whose number of firms has declined
through acquisition, merger, and buyouts.
•• The
The threat of ofSubstitutes
intensity - incumbent’s
Rivalrous tactics profitability
- to sustain profitabilityisindetermined
such a
by the threat
setting, companies of substitutes. The more
must avoid intense brand
rivalries loyalty,
and elicit themore
passive, less the
threat of substitutes
cooperative and the
responses from closehigher the incumbent’s
competitors. The intensitysustainable
of the
profitability
rivalry in an willindustry
be. depends on several factors: industry
concentration, the tactical focus of competition, switching costs, the
• The threat of Entry- second force determining the likely
presence of exit barriers, the industry growth rate, and the ratio of
profitability of an industry or product line is the threat of
fixed to total cost (cost fixity) in the typical cost structure.
potential entrants. The higher the barriers to entry, the more
profitable an incumbent will be. Barriers to entry can arise from
• The myth of Market Share - firms must adopt tactics and elicit tactical
several factors.
responses from their rivals so that the profit potential in their effective
• The power
business of isbuyers
strategy andaway.
not eroded suppliers-
This oftenbuyers may begain-
means forsaking highly
concentrated.
share discounting and other aggressive tactics that would spiral the
industry into price wars.
A CONTINUUM OF MARKET STRUCTURES
The relationship between individual firms and the
relevant market as a whole is referred to as the industry’s
market structure and depends upon:
1. The number and relative size of firms in the
industry.
2. The similarity of the products sold by the firms of
the industry; that is, the degree of product differentiation.
3. The extent to which decision making by individual
firms is independent, not interdependent or collusive.
4. The conditions of entry and exit.
 THE FOUR MARKET STRUCTURES
Monopolistic
Pure competition
competition
a market structure characterized
very much like bypure
a large
competition,
number ofwithbuyers
the
and major
sellers distinction
of a homogeneous
being the product.
existence
Entryofanda exit
differentiated
from the
industry
Monopolyproduct.
is costless, or nearly so. Information is freely available to
all market
Oligopoly participants,
a market and there
structure is no collusionby
characterized among
onefirms in
firm
the industry.
a market structure in which the number of firms is so small
producing a highly differentiated product in a market
that the actions of any one firm are likely to have noticeable
with*Contestable
significant market is an
barriers to extreme
entry. case of purely competitive
impacts on the performance of other firms in the industry.
markets. In this market structure, break-even performance
often occurs with just a handful of firms, perhaps only one.
PRICE-OUTPUT DETERMINATION
UNDER PURE COMPETITION
Short Run
A firm in a purely competitive industry may
either make transitory profits (in excess of
normal returns to capital and entrepreneurial
labor) or operate at a temporary loss in the
short run.
 PRICE-OUTPUT DETERMINATION
UNDER PURE COMPETITION
Long run
all inputs are free to vary. Hence, no conceptual
distinction exists between fixed and variable costs.
Under long-run conditions in purely competitive
markets, average cost will tend to be just equal to
price, and all excessive profits will be eliminated.
 PRICE-OUTPUT DETERMINATION
UNDER MONOPOLISTIC COMPETITION
• Short Run
just as in the case of pure competition, a
monopolistically competitive firm may or may not
generate a profit in the short run.
• Long Run
with relatively free entry and exit into the competitive
fringe, average costs and a firm’s demand function will
be driven toward tangency at a point.
 SELLING AND PROMOTIONAL
EXPENSES

Optimal Advertising Intensity

Optimal expenditure on demand-increasing costs
like promotions, couponing, direct mail, and media
advertising can be compared across firms. For
example, the total contributions from incremental
sales.
 SELLING AND PROMOTIONAL
EXPENSES

The Net Value of Advertising

Although advertising can raise entry barriers and
maintain market power of dominant firms, the
economics of information argues that by giving
consumers information, advertising can reduce the
prices paid.
 COMPETITIVE MARKETS UNDER
ASYMMETRIC INFORMATION

Lemons markets
asymmetric information exchange leads
to the low-quality products and services
driving out the higher quality products
and services.
 COMPETITIVE MARKETS UNDER
ASYMMETRIC INFORMATION
Incomplete versus Asymmetric Information

Incomplete information
is associated with uncertainty, and uncertainty is pervasive.
Practically all exchanges, whether for products, financial
claims, or labor services, are conducted under conditions of
uncertainty.
Asymmetric information exchange
refers to situations in which either the buyer or the seller p
ossesses information that the other party cannot verify or to
which the other party does not have access.
 COMPETITIVE MARKETS UNDER
ASYMMETRIC INFORMATION
Search Goods versus Experience Goods

Search goods
products and services whose quality can be
detected through market search.
Experience goods
products and services whose quality is
undetectable when purchased, it can only
be detected through experience in using the
product.
 COMPETITIVE MARKETS UNDER
ASYMMETRIC INFORMATION
Adverse Selection and the Notorious Firm

Adverse selection
a limited choice of lower-quality alternatives attributable
to asymmetric information.
Customers recognize that unverifiable private information
about experience good quality is present, yet knowledge of
any fraudulent high-price sale of low-quality products
spreads almost instantaneously throughout the
marketplace.
 COMPETITIVE MARKETS UNDER
ASYMMETRIC INFORMATION

Insuring and Lending under Asymmetric

Information: Another Lemons Market
This same adverse selection reasoning applies
beyond experience-good product markets
whenever asymmetric information is prominent.
 SOLUTIONS TO THE ADVERSE
SELECTION PROBLEM
Mutual Reliance: Hostage Mechanisms Support
Asymmetric Information Exchange

For this approach to the adverse selection problem to

succeed, buyers must be convinced that fraud is more
costly to the seller than the cost of delivering the
promised product quality.
 SOLUTIONS TO THE ADVERSE
SELECTION PROBLEM
Brand-Name Reputations as Hostages

A marketing mechanism that supports asymmetric

information exchange.
Capital assets that provide future net cash flows
from repeat-purchase customers as long as the brand
reputation holds up.
 SOLUTIONS TO THE ADVERSE
SELECTION PROBLEM
Price Premiums with Non-Redeployable Assets

Non-redeployable assets are assets whose liquidation

value in second-best use is low.
Sellers of experience goods prefer the profit from defrauding
customers by delivering low-quality products. But suppose
buyers offered reliable sellers a continuing price premium above
the cost of high-quality products.