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Competitor Identification/ Mkt Definition Prerequisite for analyzing competition: - identifying your competitors - defining your market.

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Presentation on theme: "Competitor Identification/ Mkt Definition Prerequisite for analyzing competition: - identifying your competitors - defining your market."— Presentation transcript:

1 Competitor Identification/ Mkt Definition Prerequisite for analyzing competition: - identifying your competitors - defining your market

2 Competitor Identification Identifying competitors by identifying substitutes Substitutes are products whose cross- price elasticities of demand are positive There is a distinction between direct and indirect competitors Similar products in different geographic markets may not be substitutes

3 Discussion question What do you think is the Antitrust approach to market definition?

4 Market Definition Market definition describes the market in which a firm competes Two firms are in the same market if they constrain each others ability to raise price Suppose all firms collectively set prices to maximize combined profits. Would they choose to raise prices by a least 5%?

5 Market definition If the own-price elasticity of a group of firms collectively is small, then this group of firms constitutes a well-defined market Antitrust agencies (Dept of Justice) looks at the above

6 Market Structure and Competition Market structure refers to the number and distribution of firms in a market Common measures are N-firm concentration ratio and Herfindahl index The Herfindahl index of an industry depends on the nature of competition in the industry

7 A typology of competition Perfect competition: - many sellers - homogenous products -well-informed consumers can costlessly shop around

8 A typology of competition Monopoly: - no competition for output Monopolistic competition: -many sellers -each sells a differentiated product Oligopoly: -few sellers, so the actions of one firm materially affects the others

9 Discussion question What is more important: the attractiveness of an industry, or the position of a firm in an industry?

10 Industry attractiveness vs firm position Firm position is more important What explains variation in firm profitability? The remaining unexplained percentage is random error Source of variation% variation explained Business-specific effects32 Industry19 Corporate parent4 Year2

11 A Tool for Assessing Industry Attractiveness: Porter’s Five Forces Rivalry among existing industry firms Threat of substitute products Bargainingpower of buyers Bargainingpower of suppliers Threat of new entrants entrants

12 Performing the 5-forces analysis Assess each force by asking “Is it sufficiently strong to reduce/eliminate industry profits?” Internal rivalry - begin by defining market -price competition drives down prices -non price competition drives up costs -industry prices do not fall by themselves, so you ask “Who will reduce it and why?”

13 Forces that drive down prices Many sellers Stagnant or declining industry Firms have different costs Excess capacity Undifferentiated products Large/infrequent sales orders Strong exit barriers Prices/terms of sale unobservable Prices cannot be adjusted quickly

14 Threat of new entrants Entry is pervasive. Consider industry with 100 firms in 2005 Between 2005-2010, 40 new firms will enter 30-40% turnover of firms, with 12-20% of volume Entrants/exiters are smaller than estb. firms Most entrants do not survive 10yrs Entry and exit vary by industry, and are highly correlated

15 Barriers to entry Structural -control of essential resources -economies of scale or scope -marketing advantages of incumbency Strategic

16 Strategic barriers to entry First analyze entry conditions and choose entry-deterring strategy Entry conditions can be -Blockaded -Accommodated entry -Deterred entry

17 Entry deterring strategies Limit pricing - charge a low price before entry occurs Predatory pricing - charge a low price after entry occurs Capacity expansion

18 Limit pricing Incumbent sets a low price Entrant infers that post-entry price would be low as well And so will not enter Is the potential entrant’s inference about post- entry pricing rational?

19 Limit pricing Uncertainty about incumbent’s post entry price might rescue limit pricing Uncertainty may be about - Incumbent’s objectives -Incumbent’s costs - Level of market demand Does limit pricing really occur?

20 Predatory pricing Predatory firm sets a low price to drive (existing) competitors out of the market It then recovers any losses from the low price by being a monopolist It appears that predatory pricing is irrational in any finite- period interaction Yet, firms still do it Role of uncertainty and incumbent’s reputation for toughness in understanding paradox

21 Capacity expansion Do ‘large’ or ‘small’ firms have higher incentives to do it? Is it motivated just by efficiency, or by strategic desire to gain pricing-power through preemption?

22 Supplier power/buyer power Upstream suppliers have power if -they are concentrated -customers have relationship specific investments -buyers do not buy large volumes -they can forward-integrate easily -they can price-discriminate Buyer power is just flip side of the above

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