Discuss the barriers faced by firms wishing to enter an oligopolistic market structure - Essay Example

? A discussion of the barriers faced by firms wishing to enter an oligopolistic market structure BY YOU YOUR SCHOOL INFO HERE HERE Introduction An oligopoly is best defined as a market structure in which there are is small volume of sellers that dominate the industry (Hirschey 2009; Hirschey and Pappas 1995). The sellers involved in the oligopolistic market structure are usually quite large, therefore their actions and strategic intentions strongly impact the market. Therefore, sellers in the oligopoly are constantly aware of competitor actions and respond accordingly in order to outperform the small volume of competition existing in the market structure. Oligopolists regularly take into consideration the strategic responses of competition, attempting to model the most likely retaliation of important market participants in order to maintain competitive edge. Even though competition is intense between the market players, there is also considerable influence in the oligopoly to prevent new competitors from entering the market. The most common barriers for new market entry include pricing, product differentiation and consumer switching costs, as well as intellectual property and patent laws. An explanation of barriers Firms operating in an oligopolistic market structure have often achieved economies of scale, which are the specific cost advantages achieved by a firm due to its size and scope of operations in which the cost of outputs continues to decrease whilst fixed costs are able to spread over a higher volume of unit outputs (Gelles and Mitchell 1996). This is achieved through better operational efficiency and productivity that also improves variable costs along the production model. Over time, as the oligopolist achieves profit maximisation, the business is able to low the cost of capital, especially as it pertains to asset procurement, thereby increasing production output whilst experiencing better cost efficiency. Economies of scale that have been achieved through continuous operation and success in sales in a market create barriers to new entrants, especially as it pertains to pricing. Businesses in the oligopoly are able to create predatory pricing structures in an effort to undercut emerging competition attempting to enter the market. Because the business competitor has achieved economies of scale and reduced the costs of capital, they are often equipped with the operational capacity to increase production without having to incur significant costs in this manufacturing effort. One should consider the beer industry, one that is currently dominated by major players such as Anheuser-Busch and MillerCoors which account for approximately 80 percent of the total market share in the international beer industry (New York Times 2009). If either of these oligopolists is aware that a new competitor is attempting to enter the market, thus providing competitive threat, these manufacturers are able to lower the prices of their selected products and sustain these low prices even though it would, in the short-term, reduce their quarterly profit expectations. New entrants, however, would have to invest considerable capital into the systems required to produce the product, distribute the product and market it. Oftentimes, the new competitor must establish brand recognition (a costly marketing objective) that requires, oftentimes, years of dedicated promotion in marketing simply to get consumers interested in the beverage brand. Major players such as Anheuser-Busch can theoretically cut their prices by 50% on products that are homogenous in relation to the production output of the new competitor. Sustaining these prices in an effort to drive out the new competitor is relatively simplistic when economies of scale have been achieved. Why is this so important in determining barriers to new market entry in the oligopolistic market structure? The law of demand indicates that as a price decreases, consumer demand increases when all other factors remain stable (Boyes and Melvin 2007). Therefore, market characteristics and consumer behaviour is quite favourable for the major oligopolistic player, such as Anheuser-Busch, who is able to utilise this predatory pricing structure that would, ultimately, gain more consumer attention and drive the consumer segments to the cheaper brand. Especially when the brands have built up, through years of dedicated marketing, a positive brand reputation for quality and taste, a sudden price reduction on products to drive out a new competitor would be deemed considerably favourable over the new entrant with no brand identity in the market. It would be necessary for the new entrant to attempt to recapture the costs of initial investment for market entry, such as capital asset procurement and facilities construction, which often must be passed back to consumers in the form of pricing with a high margin. Unless the new entrant maintains additional revenue-producing opportunities immediately after entering the market, they will be unable to sustain market presence when a major competitor continues to utilise predatory pricing until they have successfully driven the new entrant out of the market. Pricing, however, is not the only tangible barrier to new market entry in the oligopoly. One should consider the European supermarket industry that is dominated by a handful of major competitors such as Tesco, Morrison’s, Sainsbury and ASDA. In this market, differentiation of products and services are significant competitive strategies that allow firms having rather homogenous products (e.g. produce and seafood) and attempting to illustrate to important and profitable consumer segments that these business models provide a unique type of value. These competitors have spent considerable labour and financial resources into establishing a distinct brand personality that set each competitor apart from others in the industry. Abimbola (2001) describes the process of differentiation as being able to create a powerful linkage between their specific market-based assets (e.g. better service modelling or the aesthetics of the servicescape) in order to improve consumer perceptions of brand value over that of major competitors. According to marketing theory, when a business is able to provide positive perceptions that a brand is superior, even though its products are homogenous among competition, consumers are more likely to be loyal to this company (Schiffman and Kanuk 2010). New market entrants do not have the brand potency that is necessary, and often achievable through development of loyalty programs in this particular industry, to gain market share and distinguish itself as a wholly differentiated firm. This requires time, investment into consumer relationship management techniques and modelling, as well as economic investment in the promotional process. Thus, it should be recognised that the strength of a competitive oligopolist brand, in certain industries, makes it substantially difficult to enter the market and hope to outperform competitors and seize market share with already brand-loyal consumer segments. Yet another oligopoly is the petroleum industry and new entrants in this industry have monumental problems with attempting to become a market competitor. This is a market dominated by significantly large competitors such as British Petroleum, Marathon and Shell. Over years of operation, these oligopolists have invested considerable capital into asset procurement which has improved the scope of operations and increased efficiency of production and output. During these years of operations and consultation with internal tacit knowledge holders, those with specific knowledge and experience in research and development and engineering, have come up with innovative methods of extracting product and converting technologies to many business and consumer customers. In order to protect these innovations, major players in this oligopoly are applying for and receiving patents and other protections on their intellectual property. This type of legislation and protection by companies prevent other companies from replicating their innovations, which gives them an advantage when legalities prevent other businesses from building a similar production model. In fact, in this industry, an innovation can be considered a disruptive innovation when the change to the rather homogenous processes and systems are so radically inventive that it displaces the market completely (Christensen and Raynor 2003). A new entrant attempting to outperform competitors that have developed their own unique and legally protected innovations forces a new entrant to establish their own exclusive processes and systems which not only involves substantial financial investment in research and development, but also in labour and establishment of government relationships domestic and international. These aforementioned protections make it nearly impossible for a new entrant to find success and gain market share in the petroleum industry. Conclusion Though there are other potential barriers to market entry in the oligopoly, pricing, intellectual property and patent protections, and the correlation between product/service differentiation and consumer demand pose the most significant risks to entry. A new entrant, as illustrated, does not have the capital investment or the time necessary to establish a powerful brand identity in the market to compete effectively against other established market sellers. The ability of companies that have achieved economies of scale and built up an efficient operational model with sustainable assets provides many opportunities to utilise price gouging and other predatory pricing strategies in order to create a deterrent to competitive market entry. With the ability to sustain a lower margin temporarily to drive out competitors, it would seem that pricing is one of the most significant barriers and the most advantageous competitive strategies available for establish oligopolists in an industry. References Abimbola, T. (2001). Branding as a competitive strategy for demand management in SMEs, Journal of Research in Marketing & Entrepreneurship, 3(2), pp.97-105. Boyes, W. and Melvin, M. (2007). Economics? 6th edn. Cengage Learning. Christensen, C.M. and Raynor, M.E. (2003). The innovator’s solution: creating and sustaining successful growth. Boston: Harvard Business School Press. Gelles, G.M. and Mitchell, D.W. (1996). Returns to scale and economies of scale: further observations, Journal of Economic Education, 27, pp.259-261. Hirschey, M. (2009). Fundamentals of managerial economics, 9th edn. Mason: Southwest Cengage Learning. Hirschey, M. and Pappas, J.L. (1995). Managerial economics, 8th edn. Fort Worth: Dryden. New York Times. (2009). Rising beer prices hint at oligopoly. [online] Available at: http://www.nytimes.com/2009/08/27/business/27views.html?_r=1& (accessed 12 May 2013). Schiffman, L.G. and Kanuk, L.L. (2010). Consumer Behaviour, 10th edn. Upper Saddle River: Prentice Hall International. Read More