L6 - Determinants of seller concentration Flashcards
What are 7 systematic determinants of seller concentration?
Economies of scale
Barriers to entry
Scope for discretionary, sunk cost expenditures
Regulation
The industry life cycle
Distinctive capabilities and core competences
What is economies of scale and how does it relate to seller concentration?
The output level at which the firm’s LRAC attains its minimum value is the firm’s minimum efficient scale (MES) of production
If total demand = MES, the most cost-efficient is for the industry to be served by 1 firm - close to monopoly
If total demand = N*MES - the industry can accommodate N firms producing at MES - if N is large - closer to perfect competition
If AC are app. constant over a range of output levels beyond MES, the actual number of firms might be less than the number that could be accommodated if all were operating at MES
How do barriers of entry relate to seller concentration?
Schumpeter and Austrian school emphasise the innovative role of entry in driving industry evolution
All else equal - entry likely to reduce concentration (assuming average size of entrants is smaller than incumbent firms)
Exit is likely to increase concentration - exit of incumbent firms
How does the scope discretionary, sunk cost expenditures relate to seller concentration?
Type 1/exogenous sunk cost industry - each firm incurs a fixed sunk cost to enter industry. Sunk costs are exogenous in the sense that the firm has limited discretion in choosing the levels of such expenditures. An increase in demand lead to higher entry rate and lower seller concentration
Type 2/endogenous sunk cost industry - Some sunk cost expenditure may be required in order to enter, but further substantial sunk cost expenditures are incurred subsequently, as incumbents compete to maintain or increase their own market shares. Firms respond to an increase in demand by
increasing discretionary investments (e.g. advertising) leading to entry barriers and seller concentration
How does regulation relate to seller concentration?
Policies aimed at increasing competition by discouraging restrictive practices or disallowing mergers on grounds of public interest tend to reduce concentration, or at least prevent concentration from increasing.
Conversely, policies that restrict the number of firms permitted to operate in certain industries, or grant exclusive property rights to selected firms, tend to increase concentration
How does the introduction and the growth stage of the industry life cycle relate to seller concentration?
Introduction:
o Heavy investing in R&D, first-mover advantage.
o Sales volume may be small because consumers may have a lack of awareness.
o Low seller concentration
Growth
o Market expands
o Cost savings through economies of scale.
o Prices fall, stimulating demand. Success may attract entry - further pressure on prices.
o However, due to expanding consumer demand, incumbent firms can tolerate entrants and seller concentration remains relatively low
How does the maturity and the decline stage of the industry lifecycle relate to seller concentration?
Maturity
o Growth of sales, profitability and demand approaches saturation.
o Incumbent firms start to profile themselves through large scale advertising campaigns and hence increasing entry barriers, intensifying merger and acquisition activities
o Seller concentration increases as high volume production is necessary to maintain profitability
Decline
o Declining profits and sales
o Collusion or mergers take place
o Some withdraw.
o Seller concentration remains high
How do distinctive capabilities and core competences relate to seller concentration?
Distinctive capabilities - architecture (internal organisation, relationship with suppliers, distributors and retailers, specialised industry knowledge), innovation, and reputation
Core competences - derive from the firm’s specialised knowledge and the ways in which this knowledge is protected from imitation and used to establish and maintain an edge over competitors. Flexibility and adaptability to changing environment.
Key to staying ahead - protect the firm’s specialised resources and competences from imitation
What do all the systematic factors assume?
That the observable characteristics of an industry or its incumbent firms are the ultimate source of the competitive advantages that will determine the performance of the industry’s most successful firms. In turn, the most successful firms’ performance has major implications for the number and size distribution of firms the industry is ultimately capable of sustaining
What thought is the random growth hypothesis based on?
Individual firms’ growth over any period is essentially random
The distribution of strong and weak growth performance between firms is essentially a matter of chance
Past growth is not a reliable indicator of future growth
Important: the random growth hypothesis does not rule out the possibility that ex post (with the benefit of hindsight), strong growth performance can be attributed to ‘systematic’ factors such as successful innovation. Rather, it implies that growth originating from these factors cannot be predicted ex ante (before the event).
Systematic factors may determine growth, but these factors are distributed randomly across firms
What are the implications of random growth for the long-run trend in seller concentration?
That growth/decline cannot be predicted does not mean seller concentration also purely is chance
Simulation models show natural tendency of industry structure becoming more concentrated over time, even if growth of individual members is random
These models involve tracing the effects on seller concentration of the imposition of a sequence of random ‘growth shocks’ upon simulated (hypothetical) firm size data.
What is the Law of Proportionate Effect (LPE)?
A firm’s growth is independent of its size - Gibrat’s law og LPE
If firms’ growth rates are determined randomly, the firm size distribution tends to become skewed, with the industry comprising a few very large firms and a much larger number of smaller firms
The degree of skewness tends to increase progressively over time
It has been suggested that
a negative size–growth relationship might, at least in part, be an artefact of the
way in which many empirical tests are constructed.
Elaborate
The tests have yielded mixed results
Specifically, their reliance on data for firms that survived over the sample period raises the possibility that a type of sample selection bias or survivorship bias might be responsible for a negative reported size–growth relationship.
The validity of LPE might be limited to firms operating above a certain size or MES - long-term survival of small firms depend upon their ability to achieve MES - hence there might be rapid growth at the lower end of size distribution
Survivorship bias - data observed and recorded only for the firms that survived from the start to the end of the observation period
What is the minimum efficient scale?
MES - the output level beyond which the firm can make no further savings in LRAC through further expansion
i.e. achieved when all economies of scale are exhausted
Once MES is achieved, it is possible that a firm may be able to produce at the minimum LRAC over a wide range of output levels
For any range of output levels over which the LRAC function is flat, the firm experiences constant returns to scale - elongated U-shape or L-shape
When we assume constant returns to scale over all output levels, LRAC and LRMC are horizontal and equal to each other
