Evan Davis on... market power

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There’s a particularly interesting kind of relationship that arises a lot in business. It’s between companies that have something to sell and other companies that are well suited to selling them.

You might find it, for example, with a farmer and his eggs, and a supermarket for example. It’s arising a lot with the internet at the moment. You’ve got book publishers and Amazon, you have hotel companies trying to sell through hotels.com or Expedia or other travel sites, you’ve got record producers trying to sell through iTunes.

Now there’s a very interesting little rule about companies that do business with each other along a chain of supply, and the rule is this: it’s that the person in the chain who has the most market power and gets most of the profit is probably the one who’s in the least competitive bit of the chain.

So you have this very interesting feature, don’t you? That even though one might think that the egg producer is the most important person in the chain of getting eggs to customers, the farmer may end up with very little of the profit if there are lots of farmers and there’s only one supermarket. The supermarket will be more important than the farmers in that market because there’s just one supermarket out there, and it’s the supermarket who will thus control the market and corner all the profits.

Interestingly, this is an issue that is arising a lot in the web and on online sales because there are some companies in the nature of the web that establish themselves as the dominant player, that dominance then begins to feed on itself, customers go to the dominant player precisely because they’re the dominant player.

So web companies can establish very powerful positions and even though they may not have any hotels to supply rooms on, they may not produce any records, they can end up more powerful than the industries who they are actually, whose products they’re actually selling.

It’s a very tricky thing if you are in those industries trying to supply through them, and the only thing you can really do if you’re sort of selling through those kinds of companies is to make sure you nurture more then one so there’s a little bit of competition through which you can sell your product.

That’s my view: you can join the debate at the Open University.