Monopolistic and Oligopoly Market Structures

1. Introduction – Market structures and cases under study Definition – The interconnected characteristics of a market, such as the number and relative strength of buyers and sellers and degree of collusion among them, level and forms of competition, extent of product differentiation, and ease of entry into and exit from the market. Market structures under study are ones which are more pronounced than others in the real world i. e. ‘Monopolistic competition’ and ‘Oligopoly’. Very few markets in real world can be classified as perfectly competitive or as a pure monopoly.

The vast majority of firms do compete with other firms, often quite aggressively, and yet they are not price takers: they do have some degree of market power. Most markets, therefore, lie between the two extremes of monopoly and perfect competition as seen in in the below picture namely, monopolistic competition and oligopoly. Perfectly Competitive Monopolistic competition Oligopoly Pure Monopoly Fig. 1 Cases under study are – Indian restaurant market in UK (Monopolistic competitive) and AT&T’s wireless service (Oligopoly). Some interesting facts about these 2 cases: ?

Both are perfect examples for studying the behavior of Monopolistic competition & Oligopoly market structures. ?Telecommunication industry has always been a key contributor towards growth of hi-tech industry in US. (Remember Hi-tech industry alone contributed 20% towards the growth of US economy directly elevating real GDP growth by 1. 5 percentage point ). ?Indian curry has become an integral part of British cuisine, so much so that, since the late 1990s, Chicken Tikka Masala has been referred to as “a true British national dish” . AT&T was a pure monopoly protected by force of law before the breakup of the Bell System in Jan 1, 1984 . 2. A brief note on Monopolistic competition Market structure Monopolistic competition is nearer to the competitive end of the spectrum. It can best be understood as a situation where there are a lot of firms competing, but where each firm does nevertheless have some degree of market power (hence the term ‘monopolistic’ competition): each firm has some discretion as to what price to charge for its products. Key characteristics of Monopolistic competition are: A large number of sellers and buyers: Monopolistic market has a large number of sellers and buyers but each seller acts independently and has no influence on others. ?Sufficient Knowledge: The buyers have sufficient knowledge about the product to be purchased and have a number of options available to choose from. ?Differentiated Products ?Entry and exit are quite easy and the buyers and sellers are free to enter and exit the market at their own will. ?Nature of demand curve: each firm produces a product or provides a service that is in some way different from its rivals.

As a result, it can raise its price without losing all its customers. Thus its demand curve is downward sloping, albeit relatively elastic given the large number of competitors to whom customers can turn. ?Economic equilibrium in Short and long run – Profits are maximized at the output where MC = MR. Firms can make considerable short run profits. In the long run as new firms continue to enter equilibrium will be reached when only normal profit remains. 3. A brief note on Oligopoly Market structure When several firms control a significant share of market sales, the resulting market structure is called an oligopoly.

An oligopoly may engage in collusion, either tacit or overt, and thereby exercise market power. An explicit agreement in an oligopoly to affect market price or output is called a cartel. The behavior of firms in oligopoly requires game theoretic analysis. As a quantitative description of oligopoly, the four-firm concentration ratio is often utilized. This measure expresses the market share of the four largest firms in an industry as a percentage. For example, as of fourth quarter 2008, Verizon, AT&T, Sprint, Nextel, and T-Mobile together control 89% of the US cellular phone market .

Key characteristics of Oligopoly are: ?An oligopoly maximizes profits by producing where marginal revenue equals marginal costs. ?Ability to set price: Oligopolies are price setters rather than price takers. ?Barriers to entry are high. ?Number of firms: “Few” – a “handful” of sellers. ?Long run profits: Oligopolies can retain long run abnormal profits. ?Product differentiation: Product may be homogeneous (steel) or differentiated (automobiles). ?Perfect knowledge: Oligopolies have perfect knowledge of their own cost and demand functions but their inter-firm information may be incomplete. Interdependence: Each firm keeps a close eye on the activities of other firms in the industry. Decisions made by one firm invariably affect others. There is a tension between cooperation and self-interest among players. 4. Objectives of the study ?Application of the theoretical understanding vis-a-vis real world markets and draw logical conclusions. ?Game theoretic analysis of Oligopoly. ? ? 5. Assumptions and limitations Indian curry in UK ?Study takes into account restaurants which are specialized and only serve Indian curry usually competing in local markets. Study does not take into account premium hotels. AT&T in US 6. Indian curry industry in UK – Introduction The eating-out sector i. e. takeaways and restaurants is a vibrant market in the UK, with sales of some ? 28 billion. Although the sector has grown less strongly in recent years than in the late 1990s, it has still grown in real terms by around 7 per cent per annum since 2000. The sector exhibits many of the characteristics of a monopolistically competitive market. ?Large number of local buyers – In 2005, around 86 per cent of UK adults had eaten. Large number of firms – In 2005 there were nearly 9000 Indian restaurants and countless fast food outlets. ?There are relatively few or no barrier of entry and exit. ?Competitive prices – Tight Margins(around 2 per cent in the hotel business) because firms have to price very competitively to catch local customers. 6 ? Differentiated products – To attract customers, suppliers must each differentiate their product in various ways, such as food type, ambience, comfort, service, quality, advertising and opening hours. ?Demand curve – With its rising popularity Indian food accounted for 28 per cent of meals eaten out by UK adults in 2005. However as is the case with the Monopolistic competition there has been a drop in demand and market value over the years. 7. Analysis of Indian curry industry in UK Rise and fall in the demand and profits – ?Growing preference for more healthy food has shifted trends from McDonalds, Nandos, KFC and Hamburger bars towards ethnic foods. For example, in 1990s McDonalds suffered a downturn because its products were not associated with healthy eating. ?There has been a decline in demand over the years due to (A) Limited innovation with consumers looking for alternative cuisine. B) Problems on the supply side – Along with the minimum wage legislation, which is affecting the whole sector, a tightening up of the immigration laws. As the Mintel study states that only 60 per cent of these businesses survive longer than 3 years. ?Price wars resulted in prices being slashed by 20 and 30 per cent, and eventually by 50 per cent at the peak. 8 ? Cut-throat competition was eventually averted after minimum prices were fixed for curries and prices rose once again. Such activity, however, is illegal in the UK and is unlikely to last for long.

Recent developments There has been a move towards acquisitions in both the Indian takeaway and restaurant segments of the market though small in scale at the moment, but the emphasis is on trying to develop the brand identity. The premium end of the market is now the most lucrative. It will be interesting to see how the market develops over the next 10 years. 8. AT&T in US – Introduction For much of its history, AT&T and its Bell System functioned as a legally sanctioned, regulated monopoly. Divestiture took place on January 1, 1984, and the Bell System was dead.

Subsequently the entry of MCI into the marketplace changed the competitive environment. Technological advances, such as cellular telephones, allowed other firms to offer increasingly close substitutes, moving AT&T to oligopoly status. AT&T wireless exhibits many of the characteristics of an Oligopoly market ? Barriers to entry are high – Economies of scale, high capital investment, patents, licenses, access to expensive and complex technology and strategic actions by incumbent firm. ?Ability to set price: All 4 players have been price setters by tying their services with major cell phone vendors. Number of firms: There are 4 key players and have 82. 5% of the market share between them. ?Long run profits: All the players have retained long run abnormal profits. High barriers of entry prevent sideline firms from entering market to capture excess profits. ?Product differentiation: As is evident from the table 1, all 4 players are offering homogeneous products with a slight variation in the network they support. ?Interdependence: All the 4 players have been playing strategic games to outdo their rivals. This includes tying with cell phone manufacturers, to giving access to their for application developers. . Analysis of AT&T wireless in US As is the case with Oligopoly, there always have been strategic moves by 4 major players to undercut each other’s profits and acquire market share. Sample these chains of events from 1984 to 2010. ?Post 1984 – Price undercut by MCI, Sprint and other long-distance service providers driving prices to competitive levels alongside acquiring market share. From 1984 to 1989, AT&T’s share of revenue fell from 90% by 20 percentage points, while the shares of MCI from 5% to 13% and those of Sprint increased from 3% to 9%. From 1990-1993 – MCI and Sprint stopped undercutting AT and market shares were relatively stable, with AT losing only 3 percentage. ?End of 1993 – AT had 65% of the market, and MCI and Sprint combined had 29%. ?1995 – Long-distance telephone services tacitly colluded. Though marginal costs of the firms fell steadily AT raised its price six times, and each time MCI and Sprint quickly matched AT’s price. The Lerner Indexes for the various long-distance services exceeded 60%, which is far from competitive behavior. 12 ?

October 5, 1999 – Merger of Sprint Corporation and MCI WorldCom on announced, however the deal didn’t go through. Had the merger deal been completed, combined entity would have been the largest communications company in the US. ?January 2010 – Apple announced that AT&T will be the exclusive 3G wireless carrier for the much-anticipated new product. ?Feb 2011 – AT&T lost its exclusive hold on the iPhone in the U. S, as Verizon Wireless began selling the device to its customers. ?Mar 9, 2011 – Deutsche Telekom was mulling a sale of T-Mobile USA to Sprint Nextel Corp. Mar 22, 2011 – AT&T Inc. agrees to buy T-Mobile USA from Deutsche Telekom AG for $39 billion to create America’s largest mobile-phone company. Key featuresT-MobileAT&T WirelessSprintVerizon Wireless National CoverageNational CoverageNational CoverageNational Coverage GSMGSMGSMGSM CDMACDMACDMACDMA 3G3G3G3G Rollover minutesRollover minutesRollover minutesRollover minutes Pre-Paid PlansPre-Paid PlansPre-Paid PlansPre-Paid Plans My FavesMy FavesMy FavesMy Faves Carrier statsT-MobileAT&T WirelessSprintVerizon Wireless Subscribers30. 8M 71. 3M 51. 9M 67. 2M Market share17. 80%25. 90%17. 0%21. 50% NetworkGSM GSM/UMTS CDMA/iDEN CDMA/EVDO Number of currently available phones28433231 Number of currently available plans33131425 Table 1. Comparison of top 4 Wireless players in US 10. Comparative Analysis – Indian curry industry and AT&T wireless FactorsIndian curry industryAT&T wireless IndustryRestaurantTelecommunication(Hi-tech industry) Cost of EntryNot highProhibitively high Barriers of entryVery minimalEconomies of scale, high capital investment, patents, No. of players9000+4 PricingHigher than Market AverageRigid pricing Growth for past 10 yearsAround 7% Around 18%

SupplyLower than DemandIn equilibrium with Demand Govt, RegulationRegulation is minimumThe FTC’s Bureau of Competition Major CompetitorManyVerizon, Sprint & T-Mobile Major ThreatChanging lifestyle, food preferences, entry of new players etc. Merger of competitor firms, ground breaking new technology by competitors Key to profitability and sustainabilityConstant innovation- cuisines, ambience, accessibility, be in tune with consumer taste and lifestyle Technological innovation-spending on R, capacity building, leveraging broadband, Network effect – the inherent nature of communications conomy Table 2 : Comparative analysis of Indian curry industry and Times of AT Wireless 11. Recommendation and Conclusion Indian curry industry ?They should get more innovative in terms of offerings. ?Go for branding, franchisee model. ?Operational efficiency to cut down costs. AT wireless ?Go beyond US market for long term growth. India and China are the growth engines of the world economy, it is high time that it consider entering into these markets. ?Improve on the quality of its offerings. ?Concentrate on other segments and not just the wireless.