AEC 422 Announcements Diamond Foods Case Discussion and preliminary memo – Sept 29 (next Mon.)...
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Transcript of AEC 422 Announcements Diamond Foods Case Discussion and preliminary memo – Sept 29 (next Mon.)...
AEC 422 Announcements
Diamond Foods Case Discussion and preliminary memo – Sept 29 (next Mon.)
Diamond Foods final memo due Wed Oct 1– One comprehensive analysis submitted per group
Preliminary and final memos should follow case analysis format, but especially emphasize key concepts from Unit 1.
Competitors and Competition
AEC 422
Sept 22
Unit 1Microeconomics of the Firm
Industry
An industry is a collection of firms offering goods or services that are close substitutes of each other. (V. Jain, 2007)
North American Industry Classification System (NAICS) replacing the Standard Industrial Class (SIC) codes.
Industry Definitions
NAICS Code
NAICS Description Classification Level
31-33 Manufacturing Sector
312 Beverage and tobacco product manufacturing
Subsector
3121 Beverage manufacturing Industry group
31211 Soft drink and ice manufacturing Industry
312111 Soft drink manufacturing National Industry
For detailed codes: http://www.census.gov/naics/2007/naics07.xls
Other Empirical Approaches
– Bureau of Labor Statistics Market Classes– BLS NAICS Aggregation Titles– http://www.bls.gov/bls/naics_aggregation.htm– Products that belong to the same genre or the
same NAICS class need not be substitutes
Organization of industry
Driven by economics shaping firm size, scope, bounds, and vertical relationships
Substitutes and complements Clusters – shared resources (tourism, port,
university technology park); manufacturing and distribution relationships
Competition
If one firm’s strategic choice adversely affects the performance of another they are competitors
In practice anyone who produces a substitute product is a competitor
Competition can be either direct (between soft drinks) or indirect (soft drinks and milk)
Important implications for product development, advertising, pricing
Taco Bell: Who is my competition?
Taco Bell: Who is my competition?
Other Mexican restaurants– Abuelos?
Other Mexican fast food Other fast food restaurants
– Burgers– Pizza– Chicken– Italian
In-store Mexican RTE meals Convenience stores &
supermarket deli’s
“healthy” fast food? Fine(r) dining restaurants? How do we define “market
share”?....depends how we define the market (later)
Characteristics of Substitutes
Two products tend to be close substitutes when– They have similar performance characteristics
Kroger brand mustard vs French’s Mustard
– They have similar occasion for use and Breakfast cereal vs Pop Tarts
– They are sold in the same (geographic) market area
Various brands of gasoline in an area
Performance Characteristics
Empirical Approaches to Competitor Identification Cross price elasticity of demand
Eab = (∆Qa/Qa)/ (∆ Pb/Pb)– Substitutes, complements, or independent
If Eab > 1….then A and B are substitutes (Pepsi & Coke) If Eab < 1…then A and B are complements (hot dogs & buns)
Price for turkey increases what will happen to the quantity demanded for turkey dressing around Thanksgiving?
Price of gas increases, quantity of cars demanded decreases– Complements: Eab < 0
Price for pizza (fast food substitutes) increases, quantity demanded for Mexican fast food increases
Price for UK tuition increases, quantity demand for BCTC classes increases
– Substitutes: Eab > 0
Larger the magnitude of the cross-price elasticity, the more pronounced the effect.
Occasion for Use
Products may share characteristics but may differ in the way they are used
Orange juice and cola are beverages but (generally) used in different occasions
What about milk? Other examples – similar product – different use:
– Hiking shoes versus court shoes– Desktop vs laptop computer vs iPad
Whole and 1% Milk ConsumptionLb/capita in U.S.
Whole Milk 1% Milk
Market (Geographic) Area
Identical products in two different geographic markets may not be substitutes due to “transportation costs”– Lawn care or construction services– Banks?? Education?? Library?
Bulky products like cement cannot be transported over long distances to benefit from geographic price difference
Geographic Competitor Identification
When a firm sells in different geographical areas, it is important to be able identify the competitor in each area
Rather than rely on geographical demarcations, the firm should look at the flow of goods and services across geographic regions
Two Step Approach to Identifying Competitors in the Area
First step is to find out where the customers come from (the catchment area)
The second step is to find out where the customers from the catchment area shop
With the technological innovations, some products like books and drugs are sold over the internet bringing in virtual competitors– Amazon.com
Market Structure
Markets are often described by the degree of concentration
Monopoly is one extreme with the highest concentration - one seller
Perfect competition is the other extreme with innumerable sellers
Measuring Market Structure
A common measure of concentration is the N-firm concentration ratio - combined market share of the largest N firms (or brands)
– Ice Cream Brands Example Edys, Breyers, Blue Bell, Haagen-Dazs, and Ben &
Jerry’s make up 51.1% of the Ice Cream market share in the U.S.
Dean Foods, Kraft Foods, and Land O’ Lakes made up 37.5% of the dairy processing sales in the U.S. in 2005
Also measured as 4-firm CR or 20-firm CR
Industry Number of firms 4-firm CR 20-firm CR
Bookstores
Computer & software
Casino Hotels
Full service restaurants
Florists
12751
10133
283
195492
22753
62
51
44
9
2
70
65
76
16
4
Besanko et al, p.210, 5th Ed
Measuring Market Structure
Herfindahl index is another which measures concentration as the sum of squared market shares– Sum of the squared market shares of all the firms
in the market
Ie a market divided between 2 firms would be:– 0.52 + 0.52 = 0.5
Four Classes of Market Structure
Structure Herfindahl Index Intensity of Price Competition Perfect Competition
Usually < 0.2 Fierce
Monopolistic Competition
Usually < 0.2 Depends on the degree of product differentiation
Oligopoly 0.2 to 0.6 Depends on inter-firm rivalry Monopoly > 0.6 Light unless there is threat of
entry
Dairy Products, U.S., 2007Source: The Food Institute
Market Structure and Competition
A monopoly market may produce the same outcomes as a competitive market (threat of entry)
– Think of the one ice cream shop in a growing town
A market with as few as two firms can lead to fierce competition
With monopolistic competition, how well differentiated the products are will determine the intensity of price competition
Perfect Competition
Many sellers who sell a homogenous product and many well informed buyers (transparent market)
Consumers can costlessly shop around and sellers can enter and exit costlessly
Each firm faces infinitely elastic demand– Smallest hike in prices pushes them out of the
market
Conditions for Fierce Price Competition
Even if the ideal conditions are not present, price competition can be fierce when two or more of the following conditions are met– There are many sellers– Customers perceive the product to be
homogenous– There is excess capacity
Vertical and Horizontal Differentiation
Vertically differentiated products unambiguously differ in quality (USDA grade#1 tomatoes vs #2s)
– Bourbon? Wine? Horizontally differentiated products vary
in certain product characteristics to appeal to different consumer groups (cage free eggs, FSC)
An important source of horizontal differentiation is geographical location – taking same products to different geographic markets
Geography and Horizontal Differentiation
Video rental outlets (or grocery stores) attract clientele based on their location– Move to movie downloads?
Consumers choose the store based on “transportation costs”
Transportation costs prevent switching for small differences in price
Idiosyncratic Preferences
Tastes differ substantially across consumers– Food products, beverages, entertainment, apparel
Horizontal differentiation possible with idiosyncratic preferences
Easier to segment the market Location and Taste are important sources of
idiosyncratic preferences
BlueberryVinegar
BlueberrySyrup
N 196 243
Variable (t-ratio)ConstantMaleAgeIncomeEducationHealth Knowledge
2.0791 (4.13)***0.1994 (1.14)-1.1639 (-2.33)**0.0580 (2.75)***0.7587 (2.31)**0.0917 (0.40)
2.3174 (5.83)***0.2196 (1.68)*-1.0765 (-2.76)***0.0445 (2.46) **0.6447 (2.38)**0.4646 (2.63)***
R2 0.12 0.12Statistically significant at the 90% (*), 95%(**), or 99%(***) confidence level.
Willingness-to-pay across selected demographic variables
Search Costs and Differentiation
Search cost: Cost of finding information about alternatives
Search costs discourage switching when prices are raised
Low cost sellers try to lower the search costs (Advertising, distribution)
Some markets have high search costs (Example: ie. highly regulated products – medical care)
Switching Costs and Monopolistic Competition
An important determinant of a firm’s demand is customer switching
Switching is less likely when– Customer preferences are idiosyncratic
Dentists, hairstylists, favorite restaurant
– Customers are not well informed about alternative sources of supply
– Customers face high transportation or search costs (what has the Internet done to this lately?)
Price-Cost Margins and Concentration
Theory would predict that price-cost margins will be higher in industries with greater concentration (fewer sellers)
There could be other reasons for inter-industry variation in price-cost margins (regulation, accounting practices, concentration of buyers and so on)
Price-Cost Margins and Concentration
It is important to control for these extraneous factors if one needs to study the relation between concentration and price-cost margin
Most studies focus on specific industries and compare geographically distinct markets
Evidence on Concentration and Price
For several industries, prices are found to be higher in markets with fewer sellers
See MacDonald’s 1999 ERS article Lysine, infant formula, western railroads,
cattle slaughter See Hendrickson & Heffernan
Economies of Scale and Concentration
Industries with large minimum efficient scales compared to the size of the market tend to have high concentration
The inter-industry pattern of concentration is replicated across countries
When production/marketing enjoys economies of scale, entry is difficult and hence profits are high
Concentration and Profitability
The concentration and profitability have not been shown to have a strong relationship
Possible explanations– Differences in accounting practices may hide the
differences in profitability– When the number of sellers is small it may be due
to inherently unprofitable nature of the business