ECON90015 MANAGERIAL ECONOMICS

This assignment contributes 20% to the final assessment in this subject.

Word Limit: 2000

Cover sheet

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 Assignment Question

In this course we will examine the economics of competition and how market and product characteristics, such as industry concentration, entry barriers and product differentiation can affect price and output decisions and the profits of individual firms and entire industries.

“Industry analysis frameworks, such as Michael Porter’s¹Five Forces and Adam Brandenburger and Barry Nalebuff’sValue Net, provide a structure that enables us to systematically work through these wide-ranging and often complex issues.”

……Porter “presentsa convenient framework for exploring the economic factors that affect the profits of an industry. Porter’s main innovation is to classify these factors into five major forces that encompass the vertical chain and market competition.”  [Besankoet. al. page 258]  ¹Porter, M., Competitive Strategy, New York, Free Press, 1980.

Additional Information

The production and ultimate sale of any product requires a range of different activities arranged in a vertical chain. The vertical chain refers to the process through which a product is transformed from its raw materials to manufacturing, to marketing and distribution, to the retail sale of the final product. We refer to the flow along this vertical stream akin to a river flowing from its “upstream” origin in the mountains to its “downstream” entry into the sea. So a firm making automobiles will have “upstream” suppliers of steel which in turn will have “upstream” suppliers of iron ore which are the mining companies. In turn, the automobile company will have “downstream” firms providing the marketing such as TV advertising and the eventual retailing.

At any point on the vertical chain, separate industries can be identified by the nature of the process being undertaken and the product being produced. For example, the assembly of the automobile is a very different process and provides for a very different product from that of its “upstream” steel manufacturing suppliers.  The horizontal boundaries of the industry refers to the nature of the product and the firms that are producing this particular product. Why are some industries characterised by only a few very large firms (eg. steel making), while others have a large number of small firms (eg. ladies milliniery), and still others feature a mixture of both (eg. accountancy services)?

The five forces are internal rivalry which refers to the degree of competition or rivalry within the industry and requires the horizontal boundaries of the industry to be considered; entry which focuses on potential rivalry or competition from firms that may be able to enter the market and so requires a consideration of barriers to entry; substitute and complementary products which will influence demand for the product; and supplier power and buyer power which is about the nature of the vertical chain and the ability of suppliers to influence profits through their pricing and the ability of buyers to influence profits by the purchase prices they negotiate.

These five forces can be presented schematically as follows:

The Besankoet. al. chapter provided for you explains conceptually  how each of the five forces may influence industry profits., before providing case study examples.Begin the assignment by reading this chapter.

{You need not consider Brandenburger and Nalebuff’s Value Net in your assignment which you will also find referred to in the Besankoet. al. reference provided}.

Your assignment requires that you perform a similar case study for an Australian industry. So you will need to both identify and describe the five forces relevant to the chosen industry AND analyse their impact upon profitability.

So you can select an Australian industry that you are interested in or perhaps one that you have worked for or hope to work for. However, before finalising the industry selection it is important that you give attention to what data and information is available to allow you to complete the study.

So your assignment will commence by describing the industry that you have selected. What are the products produced and what firms operate in that industry? Necessarily, in this you will have to consider the issue of defining the market or the market boundaries. Then you have to provide information about the profits of the firms in the industry.

Now consider the nature and likely impact on profitability of each of the five forces as they apply in the selected industry.  For each of the forces, consider whether, in the case of the chosen industry, it represents a threat to profits or provides an opportunity to achieve increased profits.

A brief summary of some of the issues which are considered in detail in the Besankoet. al text follows:

Internal Rivalry–Define the market first. How or on what basis have you defined the market – is geographic location an important aspect for example? Now, how do firms in this market interact? Is the struggle for market share and increased profitability reflected in mainly price competition or non-price completion? Provide evidence and examples. So if it is non-price competition, what form does it take? Can you explain why it seems to be predominantly price or non-price competition?

Threat of entry – are the barriers to entry high or low and why. Consider brand loyalty and advertising,and economies of scale, for example. Provide evidence.

Substitutes and Complements – substitute products tend to contract industry profits as they take demand away from a firm and also will tend to increase internal rivalry. For example, the introduction and availability of the smart phone and the IPad has reduced the demand for notebook computers.

On the other had the presence of complementary products will tend to increase demand for a product and increase profits. For example, the introduction of the large screen LCD/LED and plasma television has increased the demand for the home-theatre loudspeaker systems.

Bargaining power of suppliers – is the “upstream” supplier market competitive or concentrated? If it is competitive then the prices of inputs will be determined by supply and demand. If it is concentrated then those supplier firms have market power and can raise the price at which they sell their inputs downstream. So then in that case, suppliers provide a threat to the profitability of downstream buyers.

Also has the downstream buyer undertaken any relationship specific investment with their suppliers such as locating their manufacturing plant close to the suppliers business? In this latter case the supplier has market power. Are there any substitute inputs that the downstream buyer can turn to such that they can demand lower prices from suppliers? It is not only price from suppliers that will impact on profitability, but also quality of both the inputs and the service provided which will affect the cost of the downstream buyers.

Bargaining power of buyers – is the buyer market competitive or concentrated? A concentrated buyer market will imply that the downstream buyers will purchase in greater volume such that they can demand lower prices. Has the firm entered into a relationship specific investment with its buyers?

Remember that the assignment requires both description AND analysis. So do not just describe aspects of the five forces as they relate to your chosen industry, but analyse the likely impact upon profitability of each of the five forces characteristics highlighted.

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