Market Concentration and Competition Dynamics

Concentration

• Concentration is a disincentive for new entrants
• Concentration does not give a unique indication on the intensity of competition
• To determine if concentration indicates a power imbalance in the market, several pre-conditions need to be met:
  • Homogeneous technology and minimal differentiation
  • The presence of economies of scale
  • The ability to influence supplier or distribution channels
• Concentration might be related to collusion or competitive behavior to achieve market dominance

Example: Coca-Cola and Pepsi-Cola

• The example illustrates how concentration can be influenced by the distribution of power and competitive strategies of companies
• Apple's agency model, where publishers set prices and Apple takes a commission, changed the power balance in the e-book market

Banking Sector Concentration

• In 2016, the five largest banks in Greece held nearly 97% of the assets, while in Germany and Luxembourg, the share was around 31% and 28% respectively
• This differentiation is due to structural factors, such as the presence of strong savings banks and cooperative sectors in larger countries
• Smaller euro area economies tend to have less fragmented and more concentrated banking systems

Concentration Process

• The concentration process is influenced by the minimum optimal dimension (DOM)
• A higher DOM leads to higher concentration
• Example: the automotive sector
  • If a factory's DOM is 2 million cars and the market is 10 million cars, there is space for 5 companies
  • If the market is 4 million cars, there is space for 2 companies

Demand and Supply Relationship

• The size of demand and supply influences competitive behavior
• Competitions are more apparent when supply exceeds demand, or the supply growth rate surpasses demand growth
• It’s important to consider the product life cycle

Exit Barriers

• Exit barriers hinder the exit of companies from a market
• They are structural obstacles that slow down or prevent the adjustment of supply to demand
• Factors influencing exit barriers include:
  • Idiosyncrasy of the product or service
  • Interrelation with other sectors
  • Institutional interventions
  • Internal forces within the company
• Exit barriers encourage competitive behavior

Cost Structure and Competitive Behavior

• The competitive impact of an imbalance between supply and demand is influenced by the cost structure of a sector
• When operating leverage (fixed costs constitute a significant portion of total costs) is high, companies are more likely to reduce prices, potentially eliminating profit margins
• Operating leverage is calculated as the contribution margin divided by operating income
• It represents the elasticity of operating income with respect to sales
• Break-even point is a crucial concept in this analysis, and it represents the sales level at which total revenues equal total costs

Differentiation

• Competitive intensity is inversely related to the degree of product differentiation
• Homogenous products are primarily chosen based on price
• Differentiated products enable companies to establish market dominance
• It's important to consider the costs associated with differentiation

Intensity of Competition

• The intensity of competition can be observed through the behavior of leading companies:
  • Frequent price changes (unless coordinated)
  • Repeated launch of new products
  • Investment in communication
  • Strengthening of the direct link with the market

The Threat of New Entrants

• The threat of new entrants intensifies competitive pressure
• It is influenced by entry barriers
• Incumbent companies may engage in defensive strategies to prevent new entrants
• The threat is less pronounced in growing markets

Sources of the Threat of New Entrants

• Technological innovation (e.g., mp3, e-books, electric cars)
• Changes in demand patterns (e.g., jewelry sector and the rise of “easy-to-wear” jewelry)
• Modifications in the institutional framework (e.g., government incentives)
• Evolution of economic and strategic conditions for companies operating in a sector
• Profitability conditions within a sector (e.g., gold trading during periods of crisis)

Reactions and Effects of New Entrants

• Incumbents can react to the threat of new entrants by:
  • Reducing prices
  • Acquiring struggling companies to prevent entry by other organizations
• Reactions depend on the competitive conditions of a sector

Example: Amazon

• Amazon’s dominance in e-commerce is marked by its low prices, strong infrastructure investments, and a focus on capturing market share
• The company sacrifices profits for tax optimization and market dominance, impacting traditional players

Key Takeaways

• Concentration is a measure of the market power distribution and can be influenced by factors like DOM and competitive strategies.
• Exit barriers are structural obstacles that prevent companies from exiting a market, promoting competitive behavior.
• Cost structure plays a crucial role in determining a sector's competitive dynamics, especially with high operating leverage.
• Differentiation allows companies to create a distinct market position, influencing competitive intensity.
• The threat of new entrants is a major force driving competition and prompting incumbent companies to adapt and defend their market position.
• Examples like Amazon and the e-book market demonstrate how concentration, competitive strategies, and technological evolution shape industry dynamics.