4.6 Changes in industry structure
How did the turbulence caused by new firms entering and leaving the industry, radical technological change and falling prices affect the overall industry structure? The term ‘industry structure’ refers mainly to the way in which power is distributed among firms. This can be described by factors such as the number of firms in the industry and the distribution of market shares (the market share of a firm is its share of total industry production expressed as a percentage).
An industry that has one firm with 50 per cent of the market and 50 other firms with only 1 per cent of the market (market shares must total 100 per cent) has a very different industry structure from an industry in which 10 firms each have 10 per cent of the market. An industry is described as ‘concentrated’ when a few firms have large market shares. Economists are interested in industry structure because it has implications for consumers. One of the issues is the extent to which the existence of very large firms in the industry will prevent a competitive environment, for example whether they inhibit other firms from entering the industry and discourage innovation. This issue was at the heart of the Microsoft trial, in which a very large software firm, with almost complete domination of the market, was accused of hindering competition in the industry.
In both industries, the periods of greatest technological advance were also the periods in which market shares were the most unstable and industry concentration at its lowest. Market share dynamics are important because unstable market shares mean that the status quo in the industry is being disrupted: the leaders’ lead is being challenged. When market shares are stable the existing leaders are not challenged by outsiders. Incremental technological change tends to be less disruptive to the leaders’ position than radical technological change, which is often carried out by outsiders. In fact, some have argued that competition should be measured, not by the level of ‘concentration’ (i.e. whether market share gives some firms too much power), but by the level of market share instability. As long as there is some instability the existing leaders cannot relax and are thus forced to compete.
Case study: Cars – from technological change to marketing and back?
In the automobile industry, market share instability was especially strong during the period from 1910 to 1925, which witnessed not only high entry/exit rates but also some of the most radical innovations in the industry. Market share instability then decreased as entry fell and innovation became less important. The strong economies of scale that developed in the 1920s, when most of the industry (not only Ford) began to use mass-production techniques, alongside the fall in prices, caused the industry to become increasingly concentrated. The ‘Big Three’ US automobile producers (Ford, GM and Chrysler) have dominated the US industry for most of the post-Second World War period. Concentration stopped increasing in the 1970s when the entry of foreign firms into the US market created a more competitive market. Foreign firms especially profited from the opportunity to satisfy the high demand for small cars during the oil crisis of the 1970s, an area in which they had more experience. Since the 1970s, competition has been carried out principally via advertising wars and price wars. As the twenty-first century opens, however, the automobile industry stands on the brink of a new round of technological innovation, as hydrogen looks set to replace petroleum as the standard fuel.
Question 8
Do you think there are any economic factors under-lying the varying importance of technological change over time? Is this pattern of structural change over time likely to be replicated in other industries (e.g. the PC industry)?
Answer
In the PC industry, market shares were the most stable and industry concentration the highest in the early years when IBM dominated the industry. During the late 1980s and early 1990s, the end of the IBM-compatibility era (with the rise of Wintel) and the emergence of the World Wide Web caused some disruption to the status quo, which resulted in unstable market shares and a fall in concentration. Concentration later rose again in the 2–3 year period up to the time of writing in 2001, because companies such as Dell were focusing less on innovation and more on simple measures to cut costs and hence prices so as to increase market share.
Dell computers is vowing to remain on the offensive in an ongoing PC price war, sacrificing profits in a bid to gain market shares – a strategy that the company's founder admitted could ultimately kill off a competitor.
(Popovich, 2001)
A price war is hitting PC makers hard. Many well-known names could disappear from the high street… But not all the problems are due to the downturn in the economy or the bursting of the internet bubble. Much of the suffering has been caused by Dell computer which started a price war to gain market share.
(Schofield, 2001, p. 1)
For the present let us simply note that this recent trend has, in fact, been seen by many industry analysts as a threat to the industry. Unless the PC industry goes back to the era of competing via innovation (as in the early 1990s) it is bound to end up as a traditional, stagnant industry run by a few firms that are more interested in protecting their market shares (through price reductions and advertising wars) than in the future technological growth of the industry.