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 Competition
b) 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.

The Structure Conduct Performance (SCP) Framework

Generally two approaches are used to characterize and to analyze
markets.
1) SCP approach
2) 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 neoclassical 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 the underlying

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

SCP Framework : Industry

Conduct

the

behaviour of firms as they interact

with each other and customers or
factors 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 of scarce resources or indicators which
measure the performance 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 more
efficiently 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 the questio
n 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 to
multi-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 conte
stable markets (markets no barriers to entry or exist).
Alternative to this is the Porters five forces analysis.
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Measuring the Market Concentration

Market 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 or level of
market concentration. Index depends on the number of firms in the industry
and their relative market share. Value closer to 1 says increased
monopolization).
Lorenz curve (This shows relationship between cumulative % of firms in the
industry and the cumulative % of market share)
Gini coefficient (measure of concentration in market)

Porters Five Forces Analysis

This model also can be used to classify and analyze industries. It
can be used to analyze the current market position and in formulati
on of strategic policies. This use same factors as SCP but characte
rize 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 buyers
5) The power of suppliers

Porters Five Forces Analysis

What are the key forces influencing an

organization?
Could these forces change:
Is there a case for changing strategic
relationship with suppliers?
Is there a case for forming a new relationship
with large buyers?
Are there any technical developments that rivals
could use to dramatically alter the environment?
What can management do to influence these
forces?
Are some industries more attractive than others?

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Porters Five Forces Model

Bargaining
power of
suppliers

Suppliers

Industry
competitors

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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 the
value-added process
supplier brand is powerful
JIT production
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Porters Five Forces Model

Bargaining
power of
suppliers

Suppliers

Industry
competitors

Bargaining
power of
buyers

Buyers

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Bargaining Power of
Buyers
Buyers (or Customers) are more powerful when

they are concentrated and there are few of

them (particularly true for high volume)
product is undifferentiated
backward integration (buyers collective
actions or groupings) is possible
if the selling price is unimportant to the
buyers total costs
supply industry comprises a large number of
small operators

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Porters Five Forces Model

Potential
entrants
Threat of
new entrants
Bargaining
power of
suppliers

Suppliers

Industry
competitors

Bargaining
power of
buyers

Buyers

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Threat of Potential New

Entrants
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 in
fixed 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 established
then 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 the firms
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 Model

Potential
entrants
Threat of
new entrants
Bargaining
power of
suppliers

Suppliers

Industry
competitors

Bargaining
power of
buyers

Buyers

Threat of
substitute products
and services

Substitutes
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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-price

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 Model

Potential
entrants
Threat of
new entrants
Bargaining
power of
suppliers

Suppliers

Industry
competitors
Industry
competitors
Rivalry among
existing firms

Bargaining
power of
buyers

Buyers

Threat of
substitute products
and services

Substitutes
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The Extent of Competitive Rivalry

Different market structures have different degree of competition.
Highly competitive markets, companies have regular and
extensive 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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Example: The Airline

Industry
What

is driving the current restructuring in

the passenger airline industry?

Characterise

the competitive forces in the

airline industry

bargaining power of suppliers

bargaining power of buyers
threat of entrants
threat of substitutes
competitive rivalry
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Porters Five Forces Model

Potential
entrants
Threat of
new entrants

Suppliers
Slots
& ATC : fierce competition for
Bargaining
Industry
power
of
limited supplycompetitors
suppliers
Industry
Planes : oligopolistic
Buyers
Suppliers
competitors suppliers
Bargaining
Labour : highly skilled operators
for
power of
Rivalry among
buyers
existing
firms
planes; service
providers
Fuel : main
cost, volatile
Threatvariable
of
substitute products
high ratio
of fixed to variable costs
and services
Substitutes
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Porters Five Forces Model

Potential
entrants
Threat of
new entrants

Buyers
Segments
: business v. consumer
High
Industry
poweralternatives
of
Many
for buyers
competitors
suppliers
Industry
Price sensitive
competitors
Bargaining
Elastic demand
power of
Rivalry among
buyers
Rise in web as
existing
firms channel
selling
means have
information
Threat more
of

Suppliers
Slots & ATC : fierce
competition for
limited supply
Planes : oligopolistic
suppliers
Labour : highly
skilled operators for
planes; service
providers
Fuel : main variable
cost, volatile
high ratio of fixed to
variable costs

Buyers

substitute products
and services

Substitutes
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Porters Five Forces Model

Potential
entrants

Potential Entrants Threat of

new entrants
Suppliers
BTEs
decreasing
over
time through
Slots & ATC : fierce
competition for
Buyers
decreased
regulation
High
limited supply
Segments : business v.
Industry
Planes : oligopolistic
power of
consumer
freer
competition
for
slots
competitors
suppliers
Many alternatives for
suppliers
Industry
Labour : highly
buyers
competitors of agencies
skilled operators
for
decline
in
importance
Price sensitive
Increasing Elastic demand
planes; service
providers
power of
Rise in web as selling
and exclusiveRivalry
booking
among systems
Fuel : main variable
channel means have
buyers
cost, volatile
more information
existing firms
But
high ratio of fixed
to
variable costs
still has Threat
highofMES
substitute products
and services

Substitutes
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Porters Five Forces Model

Potential Entrants
BTEs decreasing over time through
decreased regulation
freer competition for slots
decline in importance of agencies & exclusive booking systems
But still has high MES

Threat of existing firms

into new segments

Substitutes
Buyers
potential
for substitution
of
need,
High
Segments : business v.
Industry
power of
consumer
generic
substitution
and
doing
without
competitors
Many alternatives for
suppliers
Industry
buyers
competitors
all high
Price sensitive
Increasing Elastic demand
power offorRise in web as selling
also possibleRivalry
to have
among product
channel means have
buyers
more information
existing firms
product substitution
for short journeys
of travel is elastic
demandThreat
for air

Suppliers
Slots & ATC : fierce
competition for
limited supply
Planes : oligopolistic
suppliers
Labour : highly
skilled operators for
planes; service
providers
Fuel : main variable
cost, volatile
high ratio of fixed to
variable costs

substitute products
and services

Substitutes
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Porters Five Forces Model

Potential Entrants
BTEs decreasing over time through
decreased regulation
freer competition for slots
decline in importance of agencies & exclusive booking systems
But still has high MES

Threat of existing firms

into new segments

Rivalry
Buyers
manyHigh
firms of similar
size
(but
not
big : business v.
Segments
Industry
power of
consumer
competitors
Many alternatives for
enough)
suppliers
Industry
buyers
competitors
Price sensitive
simultaneous attempts to work
Increasingtogether
Elastic demand
power of
Rise in web as selling
Rivalrycompete
among
(share costs) and
(branding)
channel means have
buyers
more information
firms
move towardsexisting
price-based competition
limited effectiveness
of differentiation
High threat

Suppliers
Slots & ATC : fierce
competition for
limited supply
Planes : oligopolistic
suppliers
Labour : highly
skilled operators for
planes; service
providers
Fuel : main variable
cost, volatile
high ratio of fixed to
variable costs

from generics
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

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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, country
culture and management skills aspects of corporate strategy.
5) Analysis is predictive rather emergent.

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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.

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Forces shaping the competitive environment of the

Engineering firm
Potential
entrants
Changing Economic
Environment

Suppliers

Industry
competitors
Industry
competitors

S
Changing Political
Environment

Threat of
new entrants

Bargaining
power of
suppliers

Changing Technological
Environment

Rivalry among
existing firms

Threat of
substitute products
and services

O
Bargaining
power of
buyers

Buyers

Changing Social
Environment

Substitutes
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Self-Study
a) Apply Porter's Five Forces model to your

organization (Moratuwa University or your

Household) or any other firm/industry of your
choice. 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?

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