Wednesday, December 9, 2009

Does Current Recession Improve Contestability Of Market?

Contestable market is defined as a market structure where barriers of entry and exit are low

Does the current recession increase contestability of a market?


(1) Smaller number of firms. The current Great Recession has sent many businesses big or small under administration. As such theoretically we can say that with lesser number of firms in the industry, the level of competition will become less intense. That is because there will be lesser number of firms fighting for each other’s pie.

(2) Rival firms less likely to advertise. Firms may feel that advertising and marketing campaign during recession is just a waste of money as people are reluctant to spend. It is wiser to hoard these cash for unpredictable circumstance such as unexpected drop in sales or losses. Somehow this may also have the implication of deteriorating brand loyalty towards the company. As such it is to the best interest of new entrants as they do not have to advertise aggressively to break existing customers’ loyalty. Also this means lower sunk costs

(3) Cut in investment expenditure. Falling consumer spending will have a major setback towards the level of investment. First, drop in sales will most probably translate to falling profits or losses. As such firms will have lesser cash for reinvestment. Secondly, they may lack of the incentive to invest since there might be just few who are interested with the new products launched. Again this reduces the barriers of entry as rival firms do not have to spend aggressively on R&D to compete with products from larger firms


(1) Depends on nature of industry. Not all industries suffer a blow out during recession. In fact some even strengthened such as those which produce inferior or cheap goods. This is because inferior goods have negative income elasticity of demand. This means, a fall in income will lead to a rise in demand for those goods. New hypermarkets will find it increasingly difficult to challenge stores like Tesco, ASDA, Sainsbury and Morrison which are notoriously well known for their cheap household goods

(2) Warehouse sales. To avoid further losses, most firms will be rushing to dump their stocks into the market at an unbelievably low price. This can be seen as a form of limit pricing which prevents new companies from coming in. There is little economic incentive to do so since new firms usually have higher average costs and low price means thinner margin or even losses

(3) Strengthening of existing position. Recession could be a good news for big firms. Smaller rivals which do not have substantial supernormal profits generated during good days will not be able to withstand the onslaught of recession. As such they will be driven out of the industry. Their customers will turn away towards other bigger firms that are still standing. The rise in the concentration ratio may indicate challenge for new firms

(4) Patents protection. A patent provides protection for the invention to the owner of a patent. The protection is granted for a limited time period, generally between 15 to 20 years. However this is more than sufficient to allow the incumbent firm to monopolise the entire market share and thereby creates a powerful brand loyalty. Newcomers will have to put this under serious consideration in case their ideas may be clashed with existing ones.

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