The Concentration Ratio and the Investigation of the OFT - Essay Example

? Micro Portfolio Task Part a) The Concentration Ratio (CR) for a particular industry helps to provide the value of market concentration in an industry. This is basically the sum of output produced by a particular group of large firms. CRm= ?mi=1; si. Si is considered to be the market share and the m is the firm’s number. CR6 in this case is = 90% (sum of the market shares of the six large firms). Thus the degree of concentration in the industry is high. (b) The table of market share of the com0anies that would be taking place if the shares are revised are: Company Market Share Kellogs 15% Oaty Oats 15% Tesco Cereals 15% Quaker Oats 15% Malty Malt 15% New Cereals 15% Others (assuming that are 10 other firms) 1% (each firm) It can be commentated that the firms in the above market are facing cut-throat competition with each other. The six large producers have equal share of market demand and they have successfully threatened the entry of other firms in the industry. According to the viewpoint of the researcher, the firms in the above market are in an Oligopolistic market structure. In this type of a market structure, there are two to ten sellers in the industry. The price and output decisions undertaken by each firm is on the basis of strategic behaviour. In this type of a market structure, each of the above six firms have the power to influence the market demand. This means that each firm undertakes the decision about the prices and the quantity of output to be produced on the basis of the assumption of the business decisions undertaken by the other potential rivals in the market. However, it would be interesting to note that degree competition in the above mentioned Oligopolistic market is zero. The six large firms in the above case are enjoying equal market share and hence, equal profit. This means that the firms have undertaken the decision of Cartel in the Oligopolistic market structure. Under this regime, each of the six large firms undertakes the decision about price and output together. Cartel only arises in the market when the market power concentrates in the hands of a few firms in the industry, similar to the above case. Each of the six firms, in the above context, enjoys monopoly powers. Thus, each of them, at the given prices of their products, is enjoying a horizontal market demand curve. However, on the whole, the market demand curve is downward (Manne, 2012). Figure 1: Profit of Each Firm (Source: McEachern, 2012) The above graph shows the equal profit shared by each of the firm. Cartel in the Oligopolistic market structure which occurs when the nature of the product sold by each of the firm is less differentiated. In the above case, all the firms are engaged in the production of less differentiated cereals. The Herfindahl index is the index that measures the size of each of the firms in a particular industry and comments on the level of existing competition in there. It is calculated by the sum of the squares of the market shares by each of the firm in the industry. An increase in the value of the index indicates a fall in the level of competition on the industry and a rise in the level of market power. The value of Herfindahl index for the above concerned case: Where, N= number of firms on total. So, i = 1 to 16 (6 large and 10 small). S =market share of each firm. H= (0.152+0.152+0.152+0.152+0.152+0.152) + (0.012+0.012+0.012+0.012+0.012+0.012+0.012+0.012+0.012+0.012) = 0.136 (13.6%) The value of the Herfindahl index for the above market (13.6) indicates a high degree of market concentration among the six large firms. Under such a situation if the market shares of any of the six large firms decrease or increase then the value of the index would be increasing substantially. This is the reason for which the firms in the industry have adopted the decision of Cartel in the market (Riley, 2012). (c) It has been analyzed that the level of concentration among the firms in the above industry is high. Only six firms in the industry have occupied about 90% of the aggregate market share. On the other hand, each of the other ten remaining firms shares only a negligible amount of 1% of the market share. The market concentration in an industry is the function of the number of business firms operating in the industry and their respective market shares. The factors that affect the market concentration in an industry are: The change in the external environment of the markets often denotes the market share that a company can enjoy. For example, a new patented technology invented by a particular firm in the industry may reduce the competitive power and hence, lower the market shares of the other companies in the long run. The degree of differences among the products can also influence the changes in the extent of market concentration. For example, if a company can successfully differentiate its product from that of the other competitors in the industry, then it would be augmenting its competitive power in the market, thereby enjoying a greater share of the market. As the market share of a company increases, it would increase the level of competition in the industry. Location is also another factor that determines the competitiveness of a firm in the industry. If a firm is located in a strategic business location, then it might be able to reduce its cost of business operations. This would be a core competence for the company which would again indirectly upgrade its market share, thereby increasing the level of market concentration in the industry. If a product produced by a firm has fewer substitutes in the market, then the demand elasticity for the product is relatively inelastic in nature. The firm that produces a product with fewer substitutes in the market can manipulate the price at its own discretion. This is a situation where the firm enjoys a concentrated market power in the industry. Thus, after considering the above factors, it can be inferred that the six firms in the industry are enjoying higher market demand probably because they possess a special production technology which is unavailable with the other firms. Moreover, it might be true that the factor services or the products produced by these firms are more differentiated. It may also be possible that business locations of these firms are highly strategic in nature. All these factors have provided them with this exclusive market power in the industry (Munoz and Patrick, 2010). Part 2: (a) The food processing industry is very complicated in nature, besides being a diverse and wide one. Almost the entire world population are potential consumers of the food processing industry. The industry primarily engages in the preparation of prepared food in the market. For analysing the nature of the industry, the researcher would conduct the Porter’s Five Force Industry Analysis. Bargaining Power of the Buyers (low) As shown in Part 1, the potential sellers in the market sell products at same negotiated prices (cartel oligopolistic behaviour). Thus, the price sensitivity of the buyers’ demand is relatively low in this industry. All the sellers sell the products at the same price. Bargaining Power of the Suppliers (low) There are many suppliers of raw food materials in the industry of U.K. Therefore, the bargaining power of a single supplier in the market is insignificant. Rather, the prices at which the suppliers sell the raw food materials to the food processing companies are low as they sell them in large quantities. Number of Players in the industry (low) It has been proved above in the Herfindahl index measure that the food processing industry denotes high degree of market power concentration among the six firms. Thus, the level of existing rivalry in the market is low. There are less potential sellers in the industry. The threat of New Entrants (low) The threat of new entrants in the market is low. This is because there are only few firms in the industry that enjoy substantial shares of market demand. Therefore, these firms enjoy economies of scale in production. Economies of scale help the firms to yield output at a very low cost of production which cannot be sustained with the arrival of new entrants in the market. Threat of Substitutes (high) There are large numbers of substitutes for processed food. For example, a consumer can easily shift to unprocessed food consumption by replacing the frozen or processed food consumption. In United Kingdom, the food processing industry has an annual turnover of about € 1017 billion as recorded in 2010. The industry is large in terms of scale and scope of business operations and thus, it is subjected to generate approximately 4.25 million employment opportunities across the world. The industry exports products worth € 76.2 billion from U.K. to the rest of the world and a lower level of import ensures that the country enjoys a trade balance of about € 13.2 billion (Pearsonblog, 2008). However, this segment of business industry only invests about .53% in the purpose of research and development. The households in the European Union spend about 14.5% of consumption expenditure in this sector (Tragakes, 2011). (b) High concentration of market power in the hands of few firms in the industry reduces the net social welfare of the market. It is responsible for reducing the aggregate consumer utility or surplus in the market. Figure 2: Imperfect Competition (Source: Tucker, 2010) The above graph shows that imperfect competition in the market not only increases the process of the products, but also creates dead weight loss in the market. It is thus important for the public authorities of the nations to intervene in the market and enhance competition among the firms. The Office of Fair Trade (OFT) helps in promoting competition in the market of U.K. Thus, the OFT organization is highly rational in its purpose of work as it helps to promote the value of consumers and welfare within the market of the country (OECD, 2002). (c) If the market is not competitive in nature, then the consumers in the industry are likely to be harmed. As shown in the above diagram, the consumers in the industry could enjoy a market demand of Q1 at a price of P1 in case of a competitive market condition. However, if the market is not competitive in nature, then the quantity of output available is lower (Q2) and the price at which it is available is higher (P2). The consumer’s surplus in the market in this situation is grasped by the rise in the extent of producer’s surplus. This is the reason for promoting the interests of the consumers in the market. The OFT organization tries to reduce the level of existing competition in the economy of U.S., which would help to reduce the dead weight loss in the industry (Ross, 1979). (d) The primary task undertaken by the Office of Fair Trade (OFT) is to simply enhance competition in the market for almost all the industries in the economy. The steps undertaken by the OFT for the purpose of investigation process are: Opening the session of formal investigation. Then limited the different powers of the investigation. Prevent damage or protect the public interests. Analysis and review. Outcomes of the investigation. Setting the statement of objections. Right to reply. Making the final decision. Reviewing the whole process (OFT, 2011). (e) The investigation of the OFT in order to check the concentration of monopoly power in the Food Processing industry was conducted to reduce the information asymmetric situation in the market. As a result of the complete investigation, the degree of market imperfectness in the Food Processing industry was reduced. The market powers of the monopolists operating in the firms were also reduced to an extent due to this investigation (Nechyba, 2011). (f) The investigation of the OFT had induced the degree of market competition in the industry. This helps the consumers to make their choices in the most genuine manner. The sellers in order to win a higher share of market, in this type of a situation, would compete with each by reducing the prices of the products as much as possible. The aggregate gains that was experienced in the industry, after the increased competition, provides justification for the investigation. They were: Consumers sharing lower prices in the market. Greater discipline among the producers and the suppliers in the market. Improvement in the level of technology. More variability of the products. More innovation and intervention in the market. Rise in the level of product quality. More symmetric information in the market. (g) According to the researcher, OFT activities are highly justified and ethical in nature. The method of investigation conducted by the OFT in the industry was perfect. The norms and the regulations established in the Competition Law are also equally sound. The level of research and development investment in this industry is meagre too. It is sometimes crucial to encourage the monopolistic powers in the market, provided the concerned industry requires investing a lot for the purpose of innovation. For example, the monopoly powers of many pharmaceutical firms operating in the health industry are encouraged by the public authorities as they invest a substantial amount in research and innovation of new medicines (Richtel, 2000). Reference List Manne, G., 2012. Section 5 of the FTC Act and Monopolization Cases: A Brief Primer. [online] Available at: Read More