Pricing Strategies across Different Market Structures

Abstract

This paper details the analysis of the four distinctive market structures outlined within our textbook. This research further investigates the unique market structures and corresponding pricing strategy for perfect competition, monopolistic competition, oligopolies, and monopolies. As Griffith and Rust (1993) effectively summarized, “A firm needs to tailor its pricing strategy to the particular competitive setting it faces.” Since each of the market structures are dissimilar, each of their pricing strategies for their products will be different. A case study based upon fast food giant, Burger Kings additionally explains the relationship of each pricing strategy associated with the multiple market structures.

Perfect Competition

Description

Per Khan Academy (2019), a perfectly competitive market is a hypothetical extreme. Perfect competition technically does not exist but creates a benchmark for industries in competitive markets. The agricultural industry is often utilized as an example of being the closest industry to a perfect competitive market, as a large number of competitors supplies it and the product is almost identical within each firm. Samuelson & Marks (2015) commonly characterized perfect competition in our textbook, by four conditions: A large number of firms supply a good or service for a market consisting of a large number of consumers. No barriers to new firms entering the market. All firms produce and sell identical products. Finally, firms and consumers are described as price-takers. (Samuelson & Marks, 2015) Adam Hayes (2019) defines price-takers as an individual or company that must accept prevailing prices in a market, lacking the market share to influence market price on its own. In the end, price-taking and perfect competition became synonymous; leading to the conclusion that perfect competition is an inhospitable environment for the exercise of market creativity. (Makowski & Ostroy, 2001)

Pricing Strategies

Unfortunately, with perfect competition, individual pricing strategies cannot exist since price can only be determined by supply and demand. “Because each firm claims only a very small market share, none has the power to control price.” (Samuelson & Marks, 2015) Therefore, each firm accepts the controlled price within the market. “Perfectly competitive firms will react to profits by increasing production. They will respond to losses by reducing production or exiting the market.” (Khan Academy, 2019)

Monopolistic Competition

Description

Monopolistic competition possesses a combination of perfect competition, where all firms supply identical products and a monopoly, where a single firm sells a unique item. The main difference is product differentiation characterized by competing firms selling products that are slightly different from the other. (Samuelson & Marks, 2015) Jim Chappelow (2019) writes that monopolistic competition exemplifies an industry in which businesses offer similar products but not perfect substitutes. Certain industries such as restaurants, hotels, and other consumer service businesses are considered monopolistic competition because their products and services are not exact replicas of each other. The monopolistic competitive industry is focused on the following features: Many companies with freedom for entry and exit and differentiated yet similar products. (Pettinger, 2018) Pettinger (2018) goes on to explain firms have price inelastic demand; they become the price makers because the product is highly differentiated against its competitors. Another feature that will be explained deeper in the monopolistic competition pricing strategy is the above normal profits that can be obtained leading to greater entry into the industry from new businesses.

Pricing Strategies

There are a few limitations on monopolistic competition, which mainly derives from the pricing strategies in the industry. One of the main limitations is brand differentiation, where brand recognition creates above normal profits due to acknowledged quality differences. Because of brand differentiation, a firm could set a higher price knowing the consumer will pay more for their recognized product. (Pettinger, 2018) Another limitation set forth by Tejvan Pettinger (2018) is that a variety of new businesses to the industry do not have immediate brand loyalty and may need to reduce the outlook for their pricing strategy. Roy Ruffin (2009) breaks down the economics of monopolistic competition through variety by the following statement. “Consumers have a love for variety that is reflected in the elasticity of substitution. The higher the elasticity of substitution, the smaller the love for variety. With an infinite elasticity of substitution, consumers would be indifferent between the two products: essentially no love for variety. The greater the love for variety, the smaller the elasticity of substitution and, therefore, the smaller the elasticity of demand.”

One of the most interesting factors in pricing strategy for monopolistic competitors is locational convenience. The textbook gives the example of the supermarket industry. Though distinguishable differences in the size of the store, brands of products stocked, as well as customer service, consumers and producers view location as an important factor. Conversely, when discussing more personalized services, locational convenience is less of a factor than the services rendered.

Oligopoly

Description

An oligopoly is a unique market structure in which two or more firms compete over a given market, yet there are so few firms involved that each one can make a profit above what is earned in the more competitive industries. (Ruffin, Oligopoly, 2009) The actions of each firm directly influences the profits of one another in the industry as well as creating strict economic barriers for new firms to enter into the market. “The economic and legal concern is that an oligopoly can block new entrants, slow innovation, and increase prices, all of which harm consumers.” (Chappelow, Oligopoly, 2019) Jim Chappelow (2019) explained that steel manufacturers, oil companies, and railroads are historical oligopoly industries. Samuelson and Marks (2015) provide the aircraft manufacturing industry as an example of a current oligopoly market. The financial size of aircraft manufacturers Boeing and Airbus create massive economic barriers for new competitors and greater competition with each other, they similarly have the option of setting the price within their market.

Pricing Strategies

Oligopolies have particularly unique pricing strategies. As stated in the textbook, competition within an oligopoly is complicated by the fact that each firm’s actions, in respect to output, pricing, and advertising, affect the profitability of its rivals. (Samuelson & Marks, 2015) Either oligopoly industries can cause price wars amongst competitors or price fixing can occur within the market. Price fixing is accomplished when the industries act in correlation with one another and the group becomes a cartel. “All members of a cartel can collectively enrich themselves by restricting output to keep the price that each receives high enough to capture economic rents from consumers.” (Chappelow, Oligopoly, 2019)

Monopoly

Description

A monopoly is a theoretical construct in the era of free-market capitalism. Characterized by an entity that controls all or most of the unique market, monopolies create an unfair advantage because of absent barriers to entry in the market. “Monopolies can easily prevent competition from developing their foothold in an industry by acquiring the competition.” (Kenton, 2019) Monopolies are price makers and have absolute freedom in creating the price for the industry because of lack of competition. Another characteristic of a firm in a monopoly situation is they can produce their product at a lower cost than any competitor can because their economic portfolio allows them to purchase their inventories in huge quantities. (Kenton, 2019) Microsoft, Wal-Mart, and the United States Postal Service (USPS) are considered as monopolies based on the economic concept due to their large size and market share in their respective markets. (Simpson, 2010) Electric companies and other types of utility companies are natural monopolies. Natural monopolies are normally regulated by the government and are characterized by the lack of a substitute product and service.

Monopolies are uncommon in America because of anti-trust laws and other governmental regulations, but in other economic and political systems worldwide, monopolies are more prevalent. Eleanor Fox (2008), writing for the Antitrust Law Journal stated, “China’s new Anti-Monopoly Law prohibits abuse of administrative powers to restrict competition. However, the enforcement powers against these abuses are so weak as to nearly undermine the effort.” Most monopolistic industries in other countries are mostly state owned and allowed to exist.

Pricing Strategies

Monopolies and perfect competition are at the opposite ends of the spectrum for pricing strategies, as they are respectively, price makers and price takers. Monopolies have many different strategies they can employ depending on the situation and competitors attempting to enter the market with the final goal of maximizing profits. Janet Hunt (2019) explained that the market price is initially determined by the demand of the goods or service, but finding the correct level of output is necessary to maximize the profits. Another pricing strategy monopolies utilize is Price discrimination. Price discrimination is practiced when a company sets different prices for different market segments, even though its costs of serving each customer group is the same. (Samuelson & Marks, 2015) According to Pettinger (2019), price discrimination occurs when firms sell the same good to different groups of consumers at different prices. An example of price discrimination is an internet service provider charging different prices for residential customers versus commercial customers.

Burger King Case Study

This case study focusing on Burger King is going to delve into the correlation of its industry as part of different market structures as well as the pricing strategies it employs. The fast-food industry is highly competitive with many firms and is considered part of the market of monopolistic competition. As explained earlier in the research, monopolistic competition is characterized by many firms but the product is slightly differentiated by either the brand or quality. The fast food industry that Burger King shares can also be characterized as an oligopoly due to the control of the few companies with a worldwide influence. Earlier in the research paper, Jim Chappelow (2019) described the oligopoly market and discussed about the restriction of ease into the market, which is a characterization of Burger King and McDonalds dominance.

The restaurant industry and fast food in general is dissimilar to other industries as consumers normally have a preference of one fast food business over another because of geography and quality versus price. Burger King and McDonalds have asymmetric competitive strengths; therefore, Burger King focuses on product differentiation and optimal product positioning to appeal to their consumers. (Thomadsen, 2007) Burger King’s pricing strategy is based on demand conditions and along with McDonalds; they are the price setters of the industry. A few years ago according to Richard Gibson of the Wall Street Journal (2007), Burger King and McDonalds were involved in a discounting war when Burger King reduced the price of one of their products to compete with McDonalds Dollar Menu.

While slight product differentiation is the biggest variance in the fast food industry, advertising is key to distinguishing themselves from one another. Christina Majaski (2019) edifies that both fast food trailblazers technically has a monopoly on their own-trademarked product. While McDonalds has the iconic Big Mac, Burger King has a monopoly on the Whopper sandwich. Burger King’s value proposition remains steady as it employs differing pricing strategies amongst both monopolistic competition and an oligopoly market.

Conclusion

Pricing strategies vary through each market structure. Perfect competition is an unachievable market structure because of many market variables and are defined as price takers. Monopolistic competition is the primary market structure for most businesses. Monopolies are business opposites of perfect competition as price makers and oligopolies are extremely profitable due to the reduced amount of firms and the enormous economic barriers for entry into the market. Essentially, each market structure has unique pricing strategies and as detailed in the case study, some industries can be hybrids of multiple market structures.

References

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