An industry consists of many closely related firms offering differentiated goods and services. These firms offer similar products with minor modifications that make them different. The modifications are in terms of shape, size, or form of the products that make them different. Before starting a company, it is crucial to determine the industry structure within which the company lies.
An industry structure refers to the number of firms in an industry and their size. If an industry comprises of small size firms in relation to the size of the industry, this form is a fragmented industry. On the other hand, a consolidated industry has a few small firms having a large market share.
There are various types of industry structures depending on the concentration ratio. This ratio indicates the relative size of firms in relation to the whole industry (Scherer, 1996, p. 298). It shows if an industry consists of a few large firms, or several small firms.
Therefore, the industry structure could be a perfect competition, a monopoly, a monopolistic competition, or an oligopoly. In a perfect competition market structure, no firm dominates the other. The firms sell similar products and the prices are set through the market forces of demand and supply.
In a monopoly structure, there is only one firm in the industry. This firm sells high value products and sets the price in the market. A monopolistic competition is different from monopoly; it is an imperfect market consisting of many suppliers who sell differentiated products. These suppliers decide to set prices in the market. Finally, an oligopoly is a market structure that has a few suppliers with barriers to entry (Porter, 1979, p.15). This article analyses two industries in different market structures.
Industry A has 20 firms with a Concentration Ratio (CR) of 30%. This industry falls under a perfect competition market. In this type of industry, many firms sell similar products and services without one dominating the other (Porter, 1979, p.11). This industry has a CR of 30% meaning that, the largest firms in this industry own only 30% of the market share.
Therefore, the industry is extremely competitive with a number of the 20 firms competing fairly. No firm dominates the other in this industry through owning a large market share. In this industry, the firms sell identical products, and they take the price set by market forces of demand and supply.
This industry, being a perfect competition, has several characteristics. It consists of a many small firms that sell identical products. These firms have little influence on the price of the products. The market forces of demand and supply determine the price charged in this industry.
This industry also consists of many buyers who are price takers. Their purchase of the products does not affect the price. The products sold are similar; therefore, the consumers are indifferent when purchasing these products. They can purchase from any supplier without affecting other suppliers.
In this industry, there are no barriers to entry or exit in the industry. Firms are free to join and leave the industry without restrictions. Technological, social, legal, or economic barriers are not characteristic of this industry. Firms can choose to start or end production of their products at any time they wish.
In this industry, firms and buyers do not incur any transactional costs in their operations. The firms aim at maximizing profits at the break-even point where “marginal revenue is equal to marginal costs” (Oster, 1994, p.231). There is perfect information in the industry, and all stakeholders are aware of the price charged in the market. If a firm raises the price, consumers shift to other sellers who sell at the prevailing market price. Consumers know the prevailing market price producers know the costs and workers know their wages and salaries. This way, there is free flow of information in the market.
The forces of demand and supply influence the price in this industry in different ways. If demand increases, price goes up, and if supply increases, the price reduces and the vice versa is true. These adjustments have various implications in both the short-run and the long run. In this scenario, if demand increased prices will go up.
In the short run, it is possible for an individual firm to make profits. This phenomenon is possible because the firm can continue selling its products without incurring extra costs. However, in the end, this firm may not sustain the profits. According to Sheth and Sisodia, the industry will adjust itself by having many firms entering the industry (2001, p. 451).
They do this in an effort to take advantage of the profits that the single firm was making because, in this industry, there is free entry of firms to the market. The price will then reduce because of the many firms in the industry, and this will benefit consumers in the end. This adjustment will affect the concentration ratio of the industry. It will reduce the CR for the industry because of the many firms in the industry. The industry becomes less competitive, and some firms may again start leaving the industry.
Industry B has 20 firms and a Concentration Ratio of 80%. This industry is an oligopolistic industry because it has a high concentration of 80%. Few large suppliers dominate this industry and the leading firms take a large section of the market share (Lee, 1998, p.71). Firms in this industry compete fiercely through advertising in an effort to lead the market. Firms control the operations of the industry with restrictive terms, such as restricting the amount of production. Industry B has the characteristics of an oligopoly.
Firms in this industry aim at maximizing profits, where the marginal revenue and marginal costs are equal. The firms set the prices to charge in this market by having total control. There are barriers to enter in this industry. These include barriers related to economies of scale, access to costly and expensive technology.
Few large firms control the entire industry. These firms are large compared to the entire industry size. Firms in this industry produce either similar products or differentiated products. In an identical product oligopoly, firms produce inputs for other industries. On the other hand, a differentiated product oligopoly produces products for final consumption according to the needs of buyers.
This industry has three pricing models. The kinked demand asserts that if a particular firm raises its price, other firms will not follow that trend. In contrast, if the firm reduces its price, competitors enter the market. In collusive pricing, a cartel controls the price for their benefit. Finally, there is price leadership where a large firm dominates the others and sets the price for others to follow.
Industry B has a high concentration ratio than industry B because the industry consists of few large firms that control the market. These firms have a large market share; therefore, the concentration in the industry is high. In contrast, industry A has a low concentration ratio because of the many firms in the industry. These firms do not have any influence in the industry. The industry has competitive firms that are price takers hence the low CR.
It is not possible for small firms to thrive in industry B because, this industry has a high concentration and only large firms are able to control the market. Smaller firms will have little or no influence, and their market share is relatively small (Sheth & Sisodia, 2001, p.423). These firms are not in a position to set prices in the market since they have little influence. Only large firms with enormous influence can thrive in industry B.
It is prudent to consider the industry structure and concentration before a firm can enter the industry. This is because the size of the firm determines the category in which it falls. Small firms with a low ratio are likely to fit in competitive markets. In these markets, they will have little influence over the price. The market forces of demand and supply and demand will determine the price. On the other hand, large firms fit in oligopolistic markets. They control a large market share of the industry and influence price changes.
Lee, F. (1998). Post-Keynesian Price Theory. Cambridge: Cambridge University Press.
Oster, M. (1994). Modern competitive analysis. New York, NY: Oxford University Press.
Porter, M. (1979). How competitive forces shape strategy. Harvard Business Review, 57(2), 10-17.
Scherer, F. (1996). Industry structure, strategy, and public policy. Reading, MA: Addison-Wesley.
Sheth, J., & Sisodia, R. (2001). The rule of three: Surviving and thriving in competitive Markets. New York, NY: The Free Press.