ECO/365
In this paper, the student discusses the different market structures with focus on the oligopoly market. The student identified he food processing industry as an oligopoly industry dominated by PepsiCo, Kraft Foods, and Nestle. Moreover, competitive strategies are presented for the maximization of profits in the long run as well as the strategies that the chosen organization (PepsiCo) might consider in maximizing profits.
I chose the food processing industry for the purpose of discussion in this paper. There are three world leading companies under this industry namely, PepsiCo, Nestle and Kraft Foods. It is stated in the book Rule of Three that if competitive firms (companies) are allowed to operate with less government intervention, then a a consistent structure across nearly all mature markets will be formed. One group with three major players will compete against each other in multiple ways like offering a wide variety of related goods and services and serving most of the major market segments (Sheth and Sidodia, 2010, p. 2). Simply put, the rule suggests that, in relation to the market behavior of the three large companies, such dominance made the structure of market to become an oligopoly. An oligopoly market is made up of few “big” firms offering either nearly identical or differentiated products.
These dominant companies have the market power to manipulate prices, but because of fear of retaliation and price war, they simply resort to non-price competition. An oligopoly market is characterized by high technological or economic barriers to entry, thereby limiting the competition to few companies. Also, since these companies are competing for market share, their behavior and actions are mutually interdependent.
Before I proceed with my reason of choosing oligopoly as the focus of my analysis, let me provide some overview of the other market structures. The most ideal structure is the perfectly competitive market. Colander (2010) characterized a perfectly competitive market as a market structure in which both buyers and sellers are price takers, there is sufficiently large number of firms, there are no barriers to entry, the firms are producing identical products, there is complete information among market players, and that selling firms are profit-maximizing entrepreneurial firms (p. 317).
Another form of market structure is the monopoly of which the entire market is made up of only one company (Colander, 2010, p. 340). The key characteristic of the monopolist is that its output decision influences its price (hence, a price-maker!). This makes the price that the monopoly firm charges to be higher than that in the competitive market. Since competition is absent, the monopolist possibly enjoy above normal economic profit in the long run. Moreover, the absence of other firms to compete in the industry is due to barriers to entry like natural ability, economies of scale, and government restrictions.
The monopolistically competitive market is another form of market structure. The monopolistically competitive market is comprised of many firms selling differentiated products (Colander, 2010, p. 361). It is also characterized by having few barriers to entry. The competition in this market can take many forms. In particular, firms can compete in terms of products’ perceived attributes, advertising, and service and distribution outlets.
The market structure that has captured my interest is the oligopoly. As mentioned in the earlier discussion, the few companies in this market are mutually interdependent. Mutual interdependence, as I understand it, implies that each firm is aware of and considers the decisions and actions of the other firms. As a result, oligopolistic firms strategically plan their actions to survive and/or maintain price stability. Strategies are highly significant to the oligopolist which allows it to anticipate the possible responses of its rivals to any changes in its non-price or price decisions. Among the critical strategic decisions for each oligopoly firm include decisions of whether to lower or raise or maintain constant price, to collude or compete with rivals, to be the first company to implement new strategy, or simply wait and observe what rivals do.
Suggested Competitive Strategies to Maximize Profits in the Long Run
For the oligopoly firms to maximize profits over the long period there are several pricing and non-price strategies for them to explore.
Oligopoly companies might engage in either of the following pricing strategies: predatory pricing; limit pricing; collude; and, cost-plus pricing that is further classified into full cost pricing and contribution pricing. Predatory pricing entails keeping artificially lower price (even blower than the cost of production) to drive rivals out of the market. The strategy of limit pricing or entry forestalling price is aimed at deterring entry of new firms. The oligopoly firms may also opt for collusion with its rivals to higher the price but posts the danger of enticing new entrants in the industry. Meanwhile, in the cost plus pricing or the rule of thumb pricing involves the setting of price by getting the average costs of production and adding a fixed mark up in order to attain the desired level of profit.
As to the non-price strategies, the oligopoly firms like PepsiCo might use strategies like improving quality and after sales services, spending on advertising, engaging in sales promotion (e.g., buy-one-take-one-free), and loyalty schemes.
Recommendations to the Strategies the Organizations Might Consider to Maximize Profits
Given the competitive strategies presented above, the non-price competitive strategies are the most preferred by oligopoly firms when competing. The reason is to avoid the so-called price wars. A price war is more likely to occur when a price reduction is initiated by an oligopoly firm that is aiming to achieve strategic benefits like increase in market share. The danger of reducing price is that rival firms will respond by reducing their prices also. This eventually leads to falling revenues and profits. Hence, to avoid this unlikely situation, oligopoly firms opt to non-price competition.
Nevertheless, if the companies resort to pricing strategies like cost price pricing, such strategy will be beneficial for companies that produce several products. Also, this strategy is very useful if uncertainty (or information failure) in the market exists. The applicability of cost-plus pricing in the oligopoly market is due to the fact that the marginal revenue and marginal cost precise calculations are quite difficult. Also, this pricing strategy is commonly used in the oligopoly market since dominant firms usually have the same costs. The risk lies on the big possibility that rival firms may adopt flexible discounting strategy that will allow them to increase market share as compared to the cost-push pricing which is a rigid pricing strategy.
References
Colander, D.C. (2010). Economics. 8th Ed. New York: McGraw-Hill/Irwin.
Sheth, J., & Sisodia, J. (2010). The Rule of Three: Surviving and Thriving in Competitive Markets. New York: Boston Publishing.
