Market Structures and Relating Pricing Strategies - Research Paper Example

?Analysis of Market Structures and Relating Pricing Strategies 2. The four principal categories of market structure of relevance in the financial world, both presently and historically, are investigated. Theoretical explorations of perfect market conditions are contrasted with monopolies and monopolistic competition. Oligopolies are also described within a discussion providing a comparative framework. Various market strategies in each of the designated economic climates are described, with strengths and vulnerabilities of each as topics of investigation. 3. Introduction to Market Structures Marketplace realities surrounding the firm in question are the defining characteristic in terms of price and profitability. The decision of what the price for any given product or commodity should be made often has little to do with what it actually costs to produce and distribute a particular product. Fixed costs such as these are invariably influenced by the surrounding market structure in which the enterprise must operate. An evaluation must be made concerning what effect competitors will exert upon the market in which the firm operates. This becomes at least as important as any material production costs. Different strategies must be depending upon how other sellers are likely to react and what effect these sellers are able to exert upon the particular firm in question. The ability to shape the marketplace is an essential characteristic underscoring any market strategy, even as the rival firms try to do the same. It is necessary to cultivate an understanding of what effect the target firm's choices will have on the market place and how this interplay controls the behavior of other sellers, if any influence is meaningful (Samuelson & Marks, 2012) Depending on the political and economic environments in which the target firm finds itself, there is the possibility that other firms are effectively invisible, or remain so powerful that no plausible action can change the market. Relative to the status and assets of the target firm, other competitors may prove to be so small that their behavior has no discernible impact on the larger marketplace in which the target firm operates. In this case, it is possible to adjust prices in order to capitalize on opportunities to deliver the product or service in question – with concern only for what the law and buyer can pay. The other possibility is a setting, in which competing firms exist, that are so large and powerful relative to the target company that virtually no pricing decision will change the fundamental forces of supply and demand within the economic theater. This constitutes the reverse of the previous situation, and short-term opportunities should be considered in this case, resulting in a different strategic environment with respect to pricing decisions. The interplay can become especially complicated in the third environment, in which the other sellers delivering the commodity in question are of approximately equal size to the target firm and are, therefore, influential and influenced by one another. Each company must be concerned only partially with real costs in terms of the physical delivery of goods and services, but must instead constrain oneself based on the behavior of competitors of equal size. In this case, physical production costs may have renewed importance because the firm capable of reducing them can command an obvious advantage over its rivals. Yet such gains may be temporary as this will prompt competing operations into a drive of innovative cost-cutting, which in a competitive marketplace is likely to be ongoing. The interaction of supply and demand colors each of these scenarios. A rival firm exponentially larger than a given target firm has the potential to be much more competitive. If the disparity is too great, even if the target firm is able to deliver a commodity at a lower price, it would not be able to meet the demand already supplied by the much larger firm. Here is a problem of "getting a foot in the door," and regardless of pricing strategy, it may not be possible to influence the marketplace at all. But in the reverse situation, the larger enterprise must remain wary of the possibility of a smaller firm devising a competitive advantage that could shift demand in their favor. The ramifications of these situations and the market pricing strategies entailed by each will be detailed below. 3.1 Perfect Competition In truth, a state of perfect competition should not exist in a realistic, dynamic world. While there are some economic climates that might seem to approach a state of perfect competition, the literal achievement of that state would require nearly impossible conditions. To maintain perfect competition, the number of firms involved in a particular industry would need to be effectively infinite. This limitless number of firms would each have no discernible effect on the market whatsoever. It is a state absolutely dependent upon supply and demand. The demand itself has no limits in terms of elasticity. And with truly perfect competition, there is no discernible differentiation between products. Such a condition would also require complete market information, which is not feasible (Goodwin et al., 2009). The situation, if it could exist, would be highly efficient (Ayers & Collinge, 2003), but excess profits would not be possible, and there is no excess production capacity left over from the industry. This alone is a compelling explanation for why such a state of affairs is not possible. But a discussion of truly perfect competition is useful as a theoretical tool from which more earthly market conditions can be extrapolated. 3.2 Monopolistic Competition Monopolistic competition represents a state of affairs that is as close to perfect competition as might reasonably exist. There are neither too few nor too many sellers. There are a wide variety of buyers and sellers of various sizes, all of whom are delivering products and services that are highly similar in nature. In this instance, there can be considerable redundancy, and for the commodity in question, there could exist a vast range of substitutes very similar to one another. It becomes challenging for any single firm to completely dominate the economic theater or to eliminate a competitor. This places a limitation on the company's ability to exert leverage. Unlike perfect competition, excess production capacity can exist and production does not take place at the lowest possible cost (Investopedia, 2012). Leverage in this case would entail the ability to control supply and in that manner influence the marketplace to compel a more advantageous price. But if the industry in question is large enough to support a vast diversity of nearly redundant companies supplying highly similar products, then pure market forces take preeminence over any sort of artificial supply-based restriction. The company cannot limit its production and expect to control prices in this case. It will simply be outstripped by its competitors in terms of actual sales, unless it succeeds in creating a perception of greater value. But clearly, if a company is able to lower its price below the current market standard and remain solvent, then it will create a natural drive for other firms to follow suit, lowering their prices to match. If the environment is truly competitive, then the company able to sell at a lower price will achieve a greater market share. This allows for the possibility of a stronger position from which leverage might someday be built, with a persistent customer base with a real or convenience based preference for the particular products and services delivered by the target firm. But the ability of any single firm to entirely dominate the market is speculative, with the wide range of substitutes and alternatives that should be available. In a climate of monopolistic competition, the only reasonable expectation for a commanding domination by a single firm would be a sustained operation producing lower-priced items or services while remaining profitable. As market forces would encourage adjustment, there would have to be a single firm with the ability to sell at a price no one else could match. This would most likely entail some form of external advantage such as proprietary technology that increases productivity, or simply asymmetrical legal privileges as a result of government support or subsidy. This might take the form of tariffs in the marketplace where foreign goods are common. In the absence of an external advantage, only large-scale socioeconomic shifts that altered demand for the product or service would change the balance of pricing strategies in this economic climate. What contrasts a state of perfect competition from realistic monopolistic competition is that in the latter case, the firms do have some small influence on the market and prices. Attempts will be made to differentiate products from one another should the differences be essentially windowdressing. In a perfect state, an infinite number of firms are creating products with no differences, and thus no excess profits. But in a monopolistic competitive environment, short term trends do allow for profitability. In this situation, it is in the firm's interest to calculate the exact pricing strategy necessary to sell the entire production line, or as close to this state as can be achieved (Samuelson & Marks, 2012). 3.3 Oligopoly This situation is similar to that of monopolistic competition but represents a competitive atmosphere that has undergone a partial stabilization. In this case, a once dynamic market has become dominated by a small collection of active firms that are each balanced by the other. No single firm can exert immediate control over pricing for the commodity in question, but each influences the others. Unlike monopolistic or perfect competition, in this environment, costs to enter the business would be high to begin on a competitive footing (economicsonline.co.uk., 2012). Any firm that attempts a change in price will provoke an immediate response from the others seeking to match it. While similar in some ways to a situation of monopolistic competition, oligopoly does allow a form of cooperative control. It would theoretically be possible for a handful of manufacturers for a particular product (automobiles for instance) to confer with one another and agree on what prices they will charge, forming a de facto monopoly by collusion if antitrust laws permit. This sort of alliance would be effectively impossible in a situation of monopolistic competition, with a large number of operators of varying size producing nearly redundant products. But as the number of suppliers declines, an oligopoly and, thus, some measure of control over pricing becomes possible. Limitations in the power that an oligopoly could wield upon the marketplace include laws interfering with price-fixing and pricing agreements, as well as foreign competition. If American automobile manufacturers were all to agree on a given price, and agree on performance standards for their vehicles necessitating replacement within perhaps seven years, foreign manufacturers would have an opportunity to introduce an alternative with different pricing and performance capabilities. This would upset the collusion among the small number of firms and push the marketplace back in the direction of monopolistic competition. 3.4. Monopoly A monopoly can exist for a variety of reasons. It is possible for a new company with revolutionary technology or logistical capabilities to provide a given product or service in a way that is unapproachable by any competitor for technical or organizational reasons (Samuelson & Marks, 2012). Monopolies also come about through legal or political fiat. This can be represented by absolute government control over a particular commodity or the exploitation of the commodity. It can also occur through the nationalization of a particular industry, which the government wishes to retain tight control over. A monopoly seems advantageous to the powers that control it, because they have maximum leverage over prices and profits, without the need for efficiency. But this also creates vulnerabilities: if a monopoly dominates an industry in an open marketplace, it can become a victim of its own success. The ability to leverage profits without efficiency could prompt a foreign competitor or upstart firm to provide a superior product and claim market share through superior performance. In some cases, a legal/political monopoly exists, in which no upstarts are allowed to do business within this field. But in this case, the laws that protect the monopoly could just as easily be their downfall if the political situation changes in a way that removes the privileges that the firm once enjoyed. 4. Pricing Strategies In a state of perfect competition, there would be no essential differences between products and no excess profits, so pricing strategy would be nonexistent – supply and demand alone would control price. In a monopolistic competition, a number of strategies are available in terms of pricing in order to claim a larger market share. It might be possible for a more successful firm to take a loss by deliberately undercutting the competition in order to drive some of the many competitors out of business. This might allow a successful firm to move in the direction of an oligopoly. Packaging and marketing would matter in a monopolistic competition. A new marketing campaign for a rebranded product might allow a perception of quality to justify an increase in price, as well as profits if the consumer can be persuaded that a particular product represents a superior value, whether warranted or not. In an oligopoly, there is less room to maneuver. Any move made by one firm could be countered by other firms. It would be more difficult for any single company to try and undercut its competitors in terms of pricing strategies in order to run them out of business. A true oligopoly is whenever a handful of companies always vary similar assets and capabilities. There are few obvious pricing strategies that would allow an individual firm to pull ahead that could not be matched by their competitors. However, oligopolies do allow the possibility of alliances between the companies in order to create an effective monopoly. A handful of firms could agree on pricing and quality, thus building an artificial monopoly among themselves. But this leaves them vulnerable to antitrust legislation and foreign competition. In a monopoly, there is the possibility for price gouging. If no other firm can deliver a product or service in demand, then it is possible to leverage maximum profits. The only limiting factor in this case would be the possibility of a price so high that it sets in motion financial or political consequences that cause the loss of the monopoly. In this case, the leadership of the firm is less concerned with efficiency and innovation, and simply devoted to maintaining the highest price that the market can possibly support, with stability as a priority. 5. Case Study The American Bell telephone company was a preeminent example of a monopoly, or near monopoly in the 19th and 20th centuries until antitrust legislation in 1984 mandated its separation into separate companies. This permitted opportunities to enforce additional fees and payments from customers beyond those immediately implicit in the dispensation of the service itself (Brooks, 1976). The company could leverage additional fees from customers who sought to use a type of phone not owned or leased by the Bell company. Customers could be made to purchase the phone at cost, surrender it to the local franchise and pay an additional installation charge, and yet another monthly leasing fee in order to use another phone; in this way a monopoly can enforce greater profits, while simultaneously creating insurmountable barriers for potential competitors (Thierer, 1994). 6. Conclusion In conclusion, there appears to be considerable government incentive to avoid monopolies for most goods and services that the majority of consumers must utilize on a regular basis. A monopoly has limited investment in customer service or efficiency as consumers have nowhere else to go. An oligopoly, unless policed by strong antitrust legislations, can grow into a form of monopoly through collusion among a handful of companies. Monopolistic competition is most likely to allow efficiency, customer service, and the incentive for innovation, and the pricing strategies implying that environment is the most diverse. References Ayers, R., & Collinge, R. (2003). Microeconomics (pp. 224–225). Pearson. Brooks, J. (1976). Telephone: The first hundred years. Harper & Row. ISBN 060105402, ISBN 978-0-06-010540-2. Economicsonline.co.uk. (2012). Oligopoly. Defining and measuring oligopoly. Economics Online. Retrieved September 18, 2012 from http://economicsonline.co.uk/Business_economics/Oligopoly.html. Investopedia.com. (2012). Monopolistic competition. Investopedia US, A Division of ValueClick, Inc. Retrieved September 18, 2012 from http://www.investopedia.com/terms/m/monopolisticmarket.asp#ixzz26xQMtnqS. Goodwin, N., Nelson, J., Ackerman, F., & Weissskopf, T. (2009). Microeconomics in context (2nd ed., p. 289). Sharpe. Samuelson, W., & Marks, S. G. (2012). Managerial economics (7th ed.). Hoboken, N.J.: Wiley. Thierer, A. D. (1994). Unnatural monopoly: Critical moments in the Development of the Bell system monopoly. The Cato Journal, 14(2). Washington, D.C.: Cato Institute. Read More