Revision presentation on contestable markets

1. A2 Micro: Contestable Markets

2. A contestable market is one that is open
to actual & potential competition
Where an entrant has access
to all production techniques
available to existing
businesses and entry
decisions can be reversed
without cost

3. Conditions for contestability
Absence of sunk costs Access to technology
Low consumer loyalty Low legal barriers
• Pool of new
entrants willing and
ready to enter the
market
• No significant entry
or exit costs
• Access to the
available technology
• High rates of
customer churn

4. Cost & Price
Output (Q)
Different Shapes of Long Run Average Cost Curves
Low MES, limited scale
economies, contestable market
LRAC
Q1 Output (Q)
High MES, falling LRAC, barriers to
contestability
Extensive internal
economies of scale
leading to lower LRAC
LRAC
Natural Monopoly
Minimum
efficient
scale (MES)
Scope for many firms to
reach the MES
Q1 Q2 Q3 Q4

5. Cost & Price
Output (Q)
Different Shapes of Long Run Average Cost Curves
Low MES, limited scale
economies, contestable market
LRAC
Q1 Output (Q)
High MES, falling LRAC, barriers to
contestability
Extensive internal
economies of scale
leading to lower LRAC
LRAC
Natural Monopoly
Minimum
efficient
scale (MES)
Scope for many firms to
reach the MES
Q1 Q2 Q3 Q4

6. Different Degrees of Contestability
• All markets have the potential to be contestable
• Few are perfectly contestable
• Much depends on the nature of costs and the degree
of consumer loyalty

7. Market share of leading soft drink companies in the U.S. 2004-2014
Market share of leading carbonated soft drink companies in the United
States from 2004 to 2014
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Marketshare
Coca-Cola PepsiCo Dr Pepper Snapple Cott National Beverage Other*

8. Leading global generic drug manufacturers by market share 2013
Top 10 generic drug manufacturers - worldwide market share in 2013
Note: Worldwide
13.4%
11.9%
9.1%
8.6%
4%
3.9%
3.5%
3.2%
3.1%
2.5%
0.0% 5.0% 10.0% 15.0%
Teva Pharmacetical
Novartis
Actavis
Mylan
Aspen Pharmacare
Sun Pharmaceutical
Hospira
Daiichi Sankyo
Sanofi
Lupin
Market share
Each medicine has an approved
name called the generic name. For
example, paracetamol is a generic
name. There are several companies
that make this with brand names
such as Panadol®, Calpol®

9. Global market share held by mobile phone vendors 2009-2014
Global market share held by the leading mobile phone vendors from 2009
to 2014 (share of sales to end users)(* from 2014 onwards)
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
2009 2010 2011 2012 2013 2014
Shareofsales
Samsung Nokia/Microsoft* Apple ZTE
LG Huawei TCL Communication Research In Motion
Motorola HTC Sony/ Sony Ericsson Micromax
Xiaomi Lenovo Others

10. Leading 10 coffee shop chains in the United Kingdom (UK) 2013, ranked by store number
Leading 10 coffee shop chains ranked by number of outlets in UK in 2013
1,552
760
530
429
315
304
104
70
45
35
0 200 400 600 800 1000 1200 1400 1600 1800
Costa
Starbucks
Caffè Nero
SSP*
Wild Bean Café
M&S Café
Coffee Republic
AMT Coffee
Muffin Break
Thorntons Cafés
Number of outlets

11. Costa: number of coffee shops in the United Kingdom (UK) 2008-2015
Number of Costa coffee shops in the UK from 2008/09 to 2014/15
881
1,069
1,217
1,392
1,578
1,755
1,931
0
500
1000
1500
2000
2500
2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15
Numberofstores

13. Grocery market share in Great Britain 2015
Market share of grocery stores in Britain 12 weeks ending March 29, 2015
28.4%
17.1%
16.4%
10.9%
6%
5.1%
5.3%
3.7%
2.1%
2.9%
2.1%
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0%
Tesco
Asda
Sainsbury's
Morrisons
The Co-operative
Waitrose
Aldi
Lidl
Iceland
Other outlets
Symbols and Independent
Market share of total grocers
Grocers

14. The rise of Aldi and Lidl
• Lidl is following a strategy of rapid organic growth
• Aldi - world’s leading limited assortment grocery, with
total sales of €61bn in 2013, followed by Lidl at €59bn
• Together, the two German discounters have more than
20,000 stores across Europe, the US and Australia. Lidl
is present in 26 European markets
• Majority of their products are own-label, rather than
brands - gives them monopsony power with suppliers.
• The range suppliers are asked to provide is narrower –
perhaps four to six products compared with 30-40 at a
large grocer – driving efficiencies and big volumes

15. Contestability – Analysis of Price,
Output and Profit
• The more contestable a market is, the more likely that
an allocatively efficient outcome is achieved
• The threat of entry affects the behaviour of firms
• Often smaller disruptive businesses challenge the
monopoly power of existing businesses
• The threat of entry is as important as actual
competition

16. Cost & Price
Output (Q)
Pricing in a Contestable Market – Some Alternatives
Highly Contestable Market –
Profit Maximising Output
AC
AR
MR
MC
In the left hand
diagram draw in
the profit
maximising output
and price (label it
Q1 and P1.)
Q1
P1
C1
Price > Average Cost
Supernormal profits
High profits send
signals to other
suppliers

17. Cost & Price
Output (Q)
Pricing in a Contestable Market – Possible Long Run Equilibrium?
Highly Contestable Market –
Profit Maximising Output
AC
AR
MR
MC
In the long run if
the market is highly
contestable which
level of price and
output is probable?
(Label this Q2 and
P2).
Q1
P1
C1
When AC = AR,
normal profits made,
a return sufficient to
keep factor inputs in
their present use
P2
Q2

18. Pricing in a Contestable Market – Some Alternatives
Cost & Price
Output (Q)
Highly Contestable Market –
Pricing to Maximise Revenue
AC
AR
MR
MC
In the right hand
diagram show the
price and output
for a firm that
seeks to maximise
total revenue

19. Pricing in a Contestable Market – Some Alternatives
Cost & Price
Output (Q)
Highly Contestable Market –
Pricing to Maximise Revenue
AC
AR
MR
MC
In the right hand
diagram show the
price and output
for a firm that
seeks to maximise
total revenue
P1
Revenue maximised
when marginal
revenue = zero

20. Pricing in a Contestable Market – Some Alternatives
Cost & Price
Output (Q)
Highly Contestable Market –
Pricing to Maximise Revenue
AC
AR
MR
MC
In the right hand
diagram show the
price and output
for a firm that
seeks to maximise
total revenue
P1
C1
Revenue maximised
when marginal
revenue = zero
Still some super
normal profits made
Lower price and
higher output than
MC=MR
Revenue max means
a lower profit margin
is made – usually
good for consumer
welfare – but profit
has value too!

21. Economies of scale Vertical integration Brand loyalty
Control of important
technologies
Expertise and
reputation
Key Barriers to Contestability

22. Legal Entry Barriers
Market licences Patent protection
State awarded franchises Import controls

23. Exit Costs
Asset write-offs Lost consumer goodwill
Redundancy costs

24. Policies to make a market more
contestable

25. Policies to make a market more contestable
Deregulation of an industry Open up networks of monopolies
Tough rules on predatory pricing Policies on international trade

26. Policies to make a market more contestable
Deregulation of an industry Open up networks of monopolies
Tough rules on predatory pricing Policies on international trade

27. Policies to make a market more contestable
Deregulation of an industry Open up networks of monopolies
Tough rules on predatory pricing Policies on international trade

28. Policies to make a market more contestable
Deregulation of an industry Open up networks of monopolies
Tough rules on predatory pricing Policies on international trade

29. Key takeaway points
• The threat of competition may be a powerful
an influence on the behaviour of existing firms
• If a market is contestable, industry structure
and firm behaviour is determined by the
threat of competition - 'hit-and-run' entry
• A highly contestable market will resemble
perfect competition, regardless of the number
of firms, since incumbents behave as if there
were intense competition.

30. A2 Micro: Contestable Markets