Is UK Supermarket Sector an Oligopoly - Literature review Example

Running Header: Is UK supermarket sector an oligopoly? Student’s Name: Instructor’s Name: Course Name & Code: Date of Submission: Is UK supermarket sector an oligopoly? Introduction Markets act like a controlling agent across every economy. This is because they control how we spend, prices of goods as well as controlling entry and exit in to the market. The market structure enables an organization to determine its prices, output and the amount of profits the business might get. The above study evaluates the statement which shows that UK supermarket industry is an oligopoly. There are four major market structures that include perfect competition, monopolistic competition, and oligopoly and finally the monopoly market structure. Perfect competition market is one that is comprised of many buyers and sellers who trade similar goods. These do not have much effect on the price prevailing in the market since there are a large number of firms operating in this market (Aumann 1994, pp. 39-50). Customers do not choose what to buy since the products are similar. In order to survive in this market, two factors are important which include having a perfect knowledge and perfect mobility about every product. Perfect knowledge involves having a wider view about economic opportunities available. Clifton (2007, pp. 137-151) describes that perfect mobility is having a motive if changing an opportunity into a benefit. The monopolistic competition is a market structure that involves many buyers and sellers. These sell their goods with varying prices. This difference in price occurs as a result of presence of differentiated goods. Some of these differences appear in customer segmentation, use of varieties of branding and advertising. A monopoly is the type of an industry that produces products with no close substitutes. This market is also characterized by few barriers of entry and exit in which other people find it difficult to compete with the firm. Frank (2002) shows that one example is the City cell which had specialized in the production of mobile services in Bangladesh. The company was the first to offer these services and enjoyed the benefits of monopoly until the time Grameen phone was introduced as a competitor. An oligopoly type of market is characterized by few suppliers. Firms operating take a large percentage of market concentration and produce branded products. Characteristics of oligopoly competition An oligopoly market is characterized by few sellers and this makes it easy for one seller to be aware of others action plan. Garegnani (2000) suggests that oligopoly uses the concentration ratio that shows the four major firms in the market through percentages. One example is the cellular phone market in US which showed T-mobile, Verizon, Sprint Nextel and AT & T having 89 percent market share. Firms operate in oligopolistic competition practice restrictive trade barriers in order to increase prices and to restrict production. Most firms operating in an oligopoly market always collude due to influence of unstable markets. This reason has initiated various legal restrictions placed law enforcers to avoid collusion. Kirzner (1999, pp. 11-38) describes that collusion occurs once firms try to stabilize market prices and oligopoly firms act as market leaders in that they set prices where the rest of the firms follow this is the case of the UK supermarkets that sets prices for its dealers. The market is also comprised of high entry barriers. Some of these barriers include economies of scale, expensive technology and other strategic plans that discourage small firms. There are few firms in oligopolistic market therefore making it easy for one firm to rule the rest. There are long run profits in oligopoly market as the entry barriers restrict entry of new firms which take up profits. This involved having an actual communications among companies where one is acknowledge as the market leader. This means that the rest of the firms are to follow the prices set by the price leader for example in every economy supermarkets that operate as oligopoly. There is also a vicious competition between sellers in an oligopoly market. This is as a result of producing huge amount of goods at low prices. The results of this may lead to the effects of a perfect competition. Mas-Colell et al. (2005, p. 315) argues that on the other hand oligopoly competition may be improved by involving more firms in the industry where these firms are based at different regions but do not compete directly with each other. This is as a result of product differentiation which can also be improved in order to improve competition. Interdependence Game theory According to Heinz and Neri (1995) every firm in the oligopoly market should consider reactions of other firms in the same market before determining a particular price. This is referred to as interdependence where decisions made by one firm affect other firms’ decisions. The process results in to uncertainty and to reduce this, economists have introduced game theory. Perloff (2008) suggests that oligopoly market involves the principles of game theory where firms tend to move in a sequence which is shown in the stackelberg’s duopoly. Firms also choose the amount of quantities they would like to purchase according to how fast the products move. This can be explained giving examples of UK supermarkets where they choose their quantities simultaneously. Firms also choose their own prices in which they are to sell their goods. The high degree of interdependence of the company enable the UK supermarkets to form various price policies thus enabling them get a high amount of profit. In order to beat price competition, firms operate under strict rules and therefore act as leaders in the market. The above strategy is achieved by setting market prices where other competing firms follow. For other UK supermarkets to be more competitive in the market two factors have to be considered. One of these factors is that price charged and the other factor is the location. Interdependence between firms may result to implicit and explicit collusion between other major firms operating in the same market (Lee 2008). Other supermarkets should sell their products at reduced prices in order to compete with UK supermarkets. This is because most consumers would consider buying the same type of product at a reduced price. Once competition is initiated, the UK supermarkets will consider reducing their prices to all their dealers across their country. As a company operating an oligopoly market its products are either homogeneous for example manufacture of steel or differentiated products such as automobiles. This therefore gives the company the right knowledge necessary to determine their cost and demand functions therefore other companies find it hard to compete in the market (McNulty 1997, p. 395). The other distinct characteristic of oligopoly market involves the profit maximization conditions. Firms selling their products in an oligopoly market achieve their profits once the marginal revenue received is equal to marginal costs. The market also has the ability to set its own prices in the market where they are referred to as price setters and the rest of the supermarkets that follow their price are price takers. Barriers to entry The oligopoly market is characterized by high exit and entry barriers. Emerging firms are discouraged to venture into the market due to the strategies that have been set by the serving firms. Entry barriers may include having restrictions for example where legal agreement may be involved in that no other firm is to operate until a given period of time. The serving firms enjoy benefits that come with interdependence such as economies of scale. They also have patent rights agreed between the firm and the government. Firms in an oligopoly market have access to improved technology and this make them develop their systems to maximize their profits. Robert (1996, pp. 1-17) shows that the number of firms operating in an oligopoly market is few but the sellers are many. This means that one firm’s actions can affect the running of another firm for example in the case of UK supermarket, if one supermarket decides to introduce a strategy that pulls many firms into their stalls then this will affect the sales of other operating supermarkets. According to Roberts (1997, pp. 41-83) firms involved in oligopoly markets attain profits in the long run and this can be maintained for a long time due to the high barriers placed that prevent other investors from capturing the some extra profits. Oligopoly forms must have a perfect knowledge regarding their costs and demand functions. They should be capable of determining the first moving products in the market as this enables such firms to determine the quantity of goods to be purchased. Oligopolies produce branded products for example products that have received aggressive promotions into the market for example through excessive advertising or personal selling. According to Vela (2009) oligopoly pricing is based on four major theories. One is that firms agree to charge a particular price as in the monopoly market and this enables them achieve maximum profits. Firms in the oligopoly market also compete on price thus making price and profits be the same. The third theory about oligopoly pricing is based on price and profits which tend to be weighed between monopolies and competitive scales. It is also shown that the two can not be easily determined due to the interdependence characteristic of oligopolies. Importance of price and non-price competition There are various ways in which firms operating in one market compete for market share and increased demand. One is through price competition which involves reducing prices of goods to customer which results to increased demand of these products. Customers would always buy products sold at a lower price as long as the quality is the same. Non price competition involves all other methods that increase market share apart from reduction of prices. The UK supermarkets for example have continually used non price competition in increasing their market share and output. This has enabled the supermarket industry be in a position of surviving in the competitive market. Some of the strategies used to increase market share include use of mass media advertising in promoting their products (Goodman and Weisskopf 2009, p. 109). UK supermarket industry sell branded goods to their clients and this improves demand of products thus increase in sales. The other strategy used in increasing market share is where the UK supermarkets offer store loyalty cards where clients add points at any time they purchase goods from the supermarket. This attracts more customers in the stalls since at one time the supermarket may offer discounts to customers who have a certain number of points. The UK supermarkets also offer other services such as banking services where customers are able to purchase goods using their credit cards. Travel insurance is also provided as a method of promoting the products sold by the supermarket (Samuelson and Marks 2003). The UK supermarkets improve are able to beat competition in the market for example through the provision of services such as post office services, in- store chemists are also provided under one roof. Rupal (2010) describes that the supermarkets also provide a relaxing environment where they sell varying refreshments and provide a nursery school where children are taken to play as their parents are shopping or relaxing. UK supermarkets also provide home delivery systems and this attracts more clients especially those who may want to purchase large facilities such as refrigerator or furniture. These systems improve supermarkets’ market share as more clients will want to purchase products at places where these services are available. Discount is offered on purchase of petro at hypermarkets situated in UK. This is another system that would pull more customers to purchase the hypermarkets products since they want to same on the amount spent on petrol. These customers are said to possess imperfect knowledge on price, costs of goods and the quality of products sold by the supermarkets. The supermarkets have also introduced late working hours where many stores are now operating 24 hours a day. This makes it reliable to meet everyone’s needs especially to people who work during the night or to individuals who like parting at night and would want to buy products from the supermarkets at late hours (Roberts and Sonnenschein 1997). This strategy is one of the non price competition strategy used by UK supermarket to improve its market share and profits. The UK supermarkets also operate by use of innovative technology for example the introduction of a self scanning machine where individuals do not have to queue to be scanned which takes much time. Steve (2001) describes that instead the supermarkets used a machine where one pass and it buzz to alert people in case of a stolen property. In this world of technology many customers always want to purchase products at places that apply improved technology. This is because of reliabilities achieved for example much time is saved in the process. The UK supermarkets also make use of various financial incentives for example to improve customer base, the supermarkets offer discounts during off- peak times and this attracts more customers into the stores who benefits from the incentives. According to Pindyck and Rubinfeld (2001, p. 446) the UK supermarket have recently introduced by the help of improved technology, internet shopping to its customers. Customers in UK can purchase goods and services online using their visa cards and the goods are then delivered to their homes or business premises. However complex it may be the system is more reliable especially to customers who are so busy to walk to the stores. The improved systems have seen a significant increase in both market share and profits. These strategies used by UK supermarkets have enabled the industry to have a dominant position in the competitive market therefore becoming the prices leader. Other firms which are have not dominated the market or with less market share have to follow the changes in prices as introduced by the price leader. Examples of firms in UK that follow the price leader include mortgage lenders and petrol retailers who have to reduce their prices as a result of discounted price offered by the supermarkets. Advantages of oligopolistic competition Economies of scale Firms operating in an oligopolistic market tend to enjoy the benefits of economies of scale since the market has few participants and large producers. The firms therefore have control over price and cost. Some of the benefits enjoyed include reduction in operation costs such as transport costs. Firms are also given discounts by buying goods in bulk for example in supermarkets which buy large quantities of goods (Novshek and Sonnenschein 1997). Branded products Firms operating in an oligopolistic market sell branded products that are fast moving in the market. This benefits the firms since they do not have to use aggressive marketing tools in order to persuade people to buy. They therefore use less cost on advertising since the customers are already aware of the benefits the products offer. The products are also close substitutes and this gives customers a right to choose according to quality or price. Legal rights According to Colander (2008) the oligopolistic market operates under strict government restrictions and these barriers discourage other potential investors from investing into the industry. This benefits firms in this market as it is easy to achieve profits even in the long run. Decision making Oligopolies are able to make their own decisions given their interdependence in the market. Melvin and Boyes (2002) argue that this makes it the reason why they set prices in the market where others follow. This advantage enables firms to focus in providing other factors that increase market share in the market apart from price. These factors may include provision of financial services and discounts on goods and services. Improved technology Firms operating in an oligopolistic market are able to enjoy innovative technology. This is because they deal with large number of products where certain systems have to be introduced in order to facilitate effectiveness. Some of the introduced technology includes internet buying. Most customers would also like to purchase as a store that is associated with improved technological skills and this improves customer base thus increase in profits. Disadvantages of oligopoly market Price setting Unlike other market structures, oligopoly requires decision makers to have critical thinking on where they are to set their prices. Kreps (2000) argues that demand in oligopoly is always elastic and price is set at equilibrium point and at the kink point. Other market structures set their prices where the marginal revenue is equal to the marginal costs. The demand curve in perfect competition, monopoly and monopolistic competition is therefore well defined by the quantity of goods. In this case sellers have no worry about the reactions of other sellers. In oligopolistic on the other hand, the price leader has to set a price that will not lead to price wars in the market. In this case the reactions of other firms in the industry should be known by the market leader. This is the reason why oligopolies use non price competition in order to increase their market share as well as profits (Petri 2004). According to Arrow (2000) in oligopolistic market, tension is seen where there is competition between cooperation among firms and self interest. The leading firm must cooperate well with other firms since once the firms decide to limit their output, their prices will improve. The application of game theory as used in the oligopolistic market covers for the equilibrium point set by the oligopoly. A game is comprised by a given set of players with a set of possible strategies to use in order to obtain a win-win situation. Conclusion It has been established that oligopolistic markets find it difficult to maintain their profits and they therefore have to posses a perfect knowledge which enabled decision makers to form better strategies of improving revenue. Oligopolies have recently developed in many sectors with extraordinary competition rise which is facilitated by the increase of globalization. Product development and use of promotional techniques such as media advertising are some of the factors that have resulted to the survival of oligopolies. Some of the risen oligopolies are involved in wireless communications where the government license about three service providers into the market. The oligopoly market has many benefits since it enjoys the economies of scale and it is able to make long-term profits. According to the non price competition strategies used by the UK supermarket sector, I would critically state that the sector operates under oligopolistic competition. References Arrow, K 2000, Toward a theory of price adjustment, The allocation of economic resources, Stanford University Press, Stanford, pp. 41–51. Aumann, R 1994, Markets with a continuum of traders, vol. 32, no. 2, pp. 39–50. Clifton, J 2007, Competition and the evolution of the capitalist mode of production, Cambridge Journal of Economics, vol. 1, no. 2, pp. 137–151. 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