© 2000 John Petroff

1)- Concentration of industry and competitive strategies

Industry concentration tells whether control over the market is in few hands or is diluted among many. It is simply measured by the number of firms in the industry that control most of the market. Thus, if three firms have a combined market share of 33% of the market or more, the industry is said to be concentrated, otherwise it is not. If the combined market share of the top three firms exceeds 66%, the industry is very concentrated. The ultimate concentration is naturally when one firm has an actual or virtual monopoly and a market share of over 66%.

Table T-14.3 shows industry concentration in manufacturing (measured by the proportion of market share held by the largest four companies) for selected years.

One will observe that several industries (motor vehicles, telephone, cigarettes, photographic equipment and tires) are very concentrated. And several others (printing, soft drinks, periodicals, radio/television, paper mills, sawmills, meat packing, and even petroleum) are not concentrated. The table also shows that the degree of concentration changes over time, as one would expect from the previous discussion of consolidation in the expansion and maturation phases of the product life cycle. Thus, it is initially surprising to see just the reverse taking place in the computer industry in between 1967 and 1977 (see table above); naturally, this reflects the entry of PC manufacturing firms.

Table T-14.4 below shows the number of firms by size of work force they employ, grouped in three sizes: less than twenty, between twenty and one hundred, and over one hundred employees. The data is presented in absolute numbers and as proportions of total industry population for nine US sectors in 1987.

Manufacturing has the most concentrated industries. This conclusion can be drawn from Table T-14.4 which shows that manufacturing is the only sector in which large firms (with more than 100 employees) make up more than 10% of the business population. Yet, it is certainly true that there are plenty of large firms in the other sectors as well, especially mining, finance and transportation. Despite the large of small firms (over 95% have less than 100 employees in the entire US business population), it is well known that they have only a marginal impact on their respective markets. Just 200 of the largest American firms out of several millions own 60% of the assets and produce more than 45% of added value in the United States.

Monopolies are in principle frown upon by Western countries, but are tolerated in practice by allowing a few and decreasing number of "natural" monopolies to exist, and by granting to patent holders exclusive rights to exploit new technology. It is clear that succeeding in obtaining monopoly power is the dream of every business owner because of the profits that can be extracted from charging the highest price the market will bear (i.e. where marginal cost equals marginal revenue, as one would recall from introductory economics). But pushing competitor out of the market is difficult and prohibited by law. That is why the temporary monopoly a patent allows is such a cherished prize.

In industries where competition would be wasteful, the government must allow only a few firms to exist. This has been the case of utilities (water, electricity, gas, telephone and post office), some forms of transportation (metropolitan bus lines and passenger railways), and in some countries banking. In many countries most of these sectors used to be owned by government, and in some they still are, but a wind of privatization is blowing across the world. Where, these sectors are in private hands, the company or companies that are allowed to operate, are supervised by governmental commissions that set prices, or rates, that can be charged, as well as a few other aspects of company operations. The rates are determined so that the company can earn a "fair return" sufficient to attract financing for service improvement and expansion. When rates are set so low that companies are forced to sustain losses, the government must offset these losses with subsidies. This is especially common in metropolitan transportation to assure that even the least wealthy population will be able to afford to travel within the city. A financial analyst studying such an industry should consult transcripts of hearings where the rates are discussed by government officials, company management and users of the services.

The product life cycle showed that there is a definite pattern of increased concentration in every industry over time. The justification is the need to take advantage of cost savings from economies of scale which allow a few dominant firms to lower prices that other firms are not capable of matching. Firms that cannot expand their sales are forced to close or be absorbed by more efficient firms. To defend themselves, companies try to retain customers by differentiating their product from competitors, by obtaining patents, copyrights and other protection of industrial property, and by offering additional inducement to purchase in the form of service, packaging, convenience of location, and so on. They attempt to create niches catering to specific consumer tastes. Whether lowering prices is a deliberate predatory aggressive tactic, or just a wise managerial effort to be efficient and profitable, does not really matter. Whether the price cutting firm is a new entrant to the industry, or one of the initial product innovators, does not matter either. What counts is that all firms face the threat of being pushed out of the market no matter what niche they build. This is taking place in concentrated industries, as well as in industries that are not concentrated. In industries with a large number of firms, the battles take place on a small geographical scale (i.e. a town or county), or on few limited products.

Of course, when this takes place in a highly concentrated oligopoly of few large firms, battles can be much more spectacular and consequences more widespread. Also, larger firms of an industry have already the advantage of size and economies of scale. They are in better position to fight for market share and sustain such war because of their access to financing. Their financial strength also gives them the ability to acquire small companies if they so desire. This is evident in soft drinks where both Coca-cola and Pepsi have been buying up small bottlers in the United States and abroad.

The analysis of market composition must reveal for each significant firm

- whether they are in a position to take advantage of gaining market share,

- which of their product line is under threat from competitors,

- what strengths they can call upon,

- what weaknesses that make them vulnerable.

This is essentially an analysis of long term marketing strategy. Analyst's task is to decipher the strategies of each significant firm in the industry. The firms that must be considered significant are those that have a direct bearing on the decision at hand. If study focuses on one given company, then it is its direct competitors that should be scrutinized. If the purpose of the study is to select the most promising company in an industry, then the companies to scrutinize are the leading companies (further discussed below). Clearly, this is a lot of work. But, until this work is done, any decision that does not pay sufficient attention to potential opportunities and threats may be misguided.

It is possible that an industry may appear to have reached a steady state where each firm seems to be peacefully exploiting its own turf with no concern for what other firms do. But that is only a temporary illusion, because, as it has previously been argued, any firm that stands still will see others pass ahead of it. All firms must continuously seek to serve their market better, if only because their market changes constantly as consumer tastes and preferences change.

One such change that all firms currently experience is the globalization of their markets. These are new opportunities and new threats that result from a widening of markets with new and different clients. This is true not just for multinational firms, but even for local service companies. Thus, an analysis of participants in a market must not stop at domestic producers, but look at foreign ones as well to determine how they may (and probably will) enter domestic markets.

See review questions Q-14C1.1 through Q-14C1.12.

See research assignments .R-14C1.1 through R-14C1.3

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