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Marketplaces In order to understand any business you must first understand the environment in which it plays. Marketplaces are merely places where buyers and sellers come together. Anywhere that buyers and sellers come together to trade, there is a marketplace. It is at the New York Stock Exchange, it is the shopping mall in your favorite home town. It is EBay, Amazon, and Craigslist. It is anywhere that buyers and sellers come together to trade. Marketplaces, like businesses, are not all alike. Marketplaces have structure in which businesses compete. Marketplaces have design. You might think of marketplaces as environments. Think of salmon and bears. Salmon live in a particular environment, bears live in another. When Salmon are swimming around, having fun in the deep blue sea, they are happy. Bears like to romp above water, in and about forests and cool weather. They are happiest when their environment is clean, filled with male and female bears and few bearhunters. When Salmon go to play in the environment in which bears enjoy, salmon become something other than fish,,,,,, they become food. In the same way, when businesses fail to understand their environment,, they become food. Larger firms devour them. This isn’t an evil, it is a natural progression of the life of marketplaces. Marketplaces are, by nature, a competitive environment. Do well or become food – simple. So, studying marketplaces is important and I want to make it rather easy for you to consider as you read the text. I give to you how I think of marketplaces. You will find this in your texts but, probably, not given in this way. Recall, the environment metaphor. Bear country turns Man country gradually. Civilization encroaches into Bear-space. It is more like a transition than an event. So It is with Markets. They don’t go from one type to another as if passing through some gate where the environments are different on the other side of the gate. Rather, it is a transition, where the environments meld together, sometimes gently, sometimes with pieces of one in the side of the other. You might think of salt water and fresh water. They are different but when they merge, they form an estuary. The environment changes, sometimes slowly, sometimes quickly. I see Marketplaces on a scale, a continuum. I place it on a line with arbitrary points. On the left side is the theoretical place of Monopolies and on the other extreme side is the other theoretical place called Perfect Competition. In between, I place two other markers which, again, are theoretical spots. In reality, they just mark some place, like an estuary, where the marketplaces which touch are in the process of melding. The Marketplace Line |_______________|_____________________________|__________________________| 1 2 3 4 Those positions on the Marketplace Line are not scientific placed. They are somewhere on the line, perhaps #2 could be a bit to the right and #3 a bit to the left, who knows. These spots are not meant to be fixed spots but theoretical places which move, depending on the circumstances. But, what is true, is that #1 Marketplace type is to the extreme from #4 and #2 and #3 are in between in the relative positions in which they appear on the line. When one moves from one to the other, they will pass in the order you see, maybe not from left to right, perhaps, in some environments, the line should be horizontal; but the relative positions will be the same. In some environments, the distance from #3 to #2 will be very small and in others it will be great. But, the transition will be that #3 will not move to #1 without going through #2. The relative positions will be the same, almost everywhere. #1, I say, is where Monopolies exist. Monopolies are characterized by: Number of sellers: just one (said in a low, Sean Connery voice – there can be just one) In a real Monopoly, only is there just one seller but there are no options, no competitors, no choices. The reason Monopolies don’t really exist is that there is always another choice. You don’t have to buy. There is always the choice. There is a common misunderstanding that monopolies are those places where there is just one seller. Well, truth is; one choice. There is always that competition one-market sellers have and that is our refusal to buy. Product: same. There is one option. That option transcends the marketplace at any particular time. That product remains from time to time. The story of AT&T is on subject. There was no innovation, a black phone with a cord that curled. Then came the great innovation: white. WOW! White.. think of the brain power that it took to create WHITE. White phones, who knew! Basis of Competition: You must, or the choice to NOT buy is difficult, very difficult. Innovation: not needed. If you have to buy what I have, why change. Barrier to entry: absolute. In monopolies, it is often that it is just illegal to play if you aren’t the ONE. Copyrights, for instance, makes it illegal to use that product. Patents build barriers for years so that you can’t produce another medicine like theirs. Sometimes, it is that the resource that is needed is owned by one supplier. Weyerhaeuser bought all the alder wood forests and created a near monopoly. Seller is a price giver. There is no bargaining, take it or leave it but the seller knows, you really can’t leave it. Guess on a sliding scale, with up being high and down being low..where is the price point on the scale? High or low? Can you see why we find Monopolies repugnant. It takes away the concept of Customer Sovereignty. Demand line for product is perfectly perpendicular, Price: perfectly inelastic The only example I can think which comes close is a trash company in Bellingham, Washington. There are others like this but I am only going to think this far. That trash company, SSC, is the ONLY option you have for trash pickup. Not just that, but if you are living in a single family residence, you MUST, by law, buy their minimal product. Even if you don’t need it, you buy it – by law. Here you must, no choices. #2, in my scale is Oligopolies. Oligopolies are characterized by: Number of sellers; a few, let’s say 3. It could be four, or 2, or even five. But it is a few. I say “about 3, to be exact.” This is 3 that matter. In fact, the marketplace might have hundreds of sellers but only a handful that matter. Microchips is an Oligopoly. There are two major sellers, Intel and AMD. There are, actually, many many many more. But they are irrelevant in pricing. They make little if any difference in what the marketplace is doing. When AMD or Intel decides to do something, the Marketplace is attentive. Product; the product is different, the products change, both incrementally and “destructively.” That is, one new product will destroy the previous one. Products, between sellers, are based on Differences. Think of iphone and Samsung’s S3 phone. Both are similar in what they do but they are based on differences. Each company slams the weaknesses of what the other fails to do and extols what their product does do. Basis of Competition; Difference. A great economist, Michael Porter, said that there are two different ways to compete. You can compete on the basis of Differences and you can compete on the basis of COST (note, not price but Costs). In Oligopolies, it is all about the BIG DIFFERENCES. Innovation: Product and process innovation are high, even extreme. Be different or you are food. Not just different in comparing your product to the next best competitor but different from your LAST product. GM goes out with new cars each year that compete with Toyota as well as last year’s model. Difference is the thing. Barrier to entry. The wall is high, wide and deep and it takes a great deal to get on the other side. It is possible, but it takes a huge effort. The wall might be based on the kind of capital needed to play in that Marketplace. It might take skill and special knowledge, it might take political acumen. But, whatever barriers exist, it is near impossible to get over, but it is possible. You can, for instance, make large planes that fly hundreds of people from one continent to another. But, even if you had billions of bucks,, enough to start, what skills would you need? Where would you put it, that sort of business is not like Mary Kay products, you can’t make them in your garage. What community is going to let you build big airplanes in their neighborhood? What permits would be needed and which City Council will give them to you without, well, campaign investments? Price searcher. This is a marketplace where we are trying to find that sweet spot for price. Where, as sellers, do we place the price, high or low? As sellers, we want it as high as we can get it, that place where, based on our cost structure and the Quantity demanded, we will find that best spot, where our net profits are the highest. We must grabble with that. We don’t know so we search, We raise and lower, we study what happens. Recently, Starbucks announced that they “might” have to increase prices – price searching, discovering what resistance there is or what apathy exists at the purported price increase. If there is enough apathy from the mere suggestion, they will increase and see what happens, they will measure it by time of day of the sale, by geography, by what else is selling. It could be that raising the price of one drink which costs a great deal to make will drive people to another drink which is cheap to make. They might lose sales but increase their Net Profit. They will have many marketing and financial analysts looking to discover the BEST price. Demand Line: More perpendicular but not, moving away from perfectly perpendicular. Price: inelastic #3 in my scale is Monopolistic Competition. Monopolistic Competition Is based on: Number of sellers: LOTS. That is the precise accounting term, lots. Product: almost the same, a small difference in color, or size, or something that is based on look and feel but not any different technology, or what I call REAL difference. What is the difference between Starbucks Coffee versus Peat’s Coffee or the one other place you like going? There are missionaries of coffee who think that there are REAL differences between coffees. But really? Some think there are real differences between Pepsi and Coke, or Coke and the generic Cola Brand of your favorite grocer. Basis of Competition: mostly, it is Cost with a bit of difference. But, the big thing is cost. (note, this is NOT Price but Costs) When you lower your costs, you increase your net profits. When you lower costs in comparison to your competitors, you have options. You can return the cost advantages to either your stockholders (in dividends or investment in the future), you can return it to your employees (in higher pay or benefits), or you could return it to customers (in lower prices to them). This is where Wal-Mart, Southwest airlines, IKEA try to make their niche, in fanatical cost reductions. Innovation; not so much, mostly advertising sort of innovation, like changing the phone from black to white, staying open longer, opening a drive-up window to get your meds (Walgreens) or having your customer buy in large quantities (Costco) The product itself, however, is substantially the same and cost structures have management’s attention more than research and development. Barrier to entry: some. There is some but not so much. There might be a license to get, some hard and some difficult. If you want to go into this sort of business, you might need a license that takes a simple, small, fee. Or it might be a license that takes a special body of knowledge like CPAs or Lawyers. Notice, there are lots of them. There are some barriers, some harder to get than others, but not so much. Price searcher. The idea is to find that sweet spot where customers will pay for that difference, to add this or that to make it interesting enough so that higher prices are allowed. It takes some dancing to find where that spot is. So we search for it. Demand Line: it is on the soft side of the 45 degree curve, that is it is moving to horizontal. It isn’t horizontal. Price is elastic, but not perfectly #4 in my scale is Perfect Competition: the characteristics are: It is a theoretical place, it doesn’t exist. Number of players; unlimited, thousands, swarming Product: homogeneous, same, no difference from one seller to the other. Commodities are of this type. Basis of competition: cost, there is no difference. Innovation: no product innovation, but there is process innovation Barrier to entry: none, nada, zip, zero. This one of the reasons why there are so many competitors,, anyone can get in,,,and out, with no gateways. This is one reason why this is just a theory. There are always some barriers, if only your time, there are still scare resources which must be sacrificed. Price taker: The price is the ONLY price. Since there is NO difference between one seller’s product to another, price is all that matters. As a seller, you can’t reduce the price. Well, you can, but since price is the only thing, if you reduce your price every other competitor much match it or go out of business. They will match your price and there will be a new, lower price normal and you end up with no competitive advantage but a lower margin. You can’t raise your price because no one will buy from you. You take the price, can’t move it up or down. Demand line: perfectly horizontal. At every quantity demanded, there is still just one price. Price is perfectly elastic, perfectly. The idea that something would be perfect should suggest it doesn’t exist. In reality, there is movement up and down the line. Notice, as you move from right to left, the demand line moves from perfectly horizontal to perfectly perpendicular. As you move right to left, there are higher and higher barriers with a corresponding few number of players. As you move from right to left, price matters less and less and differences matter more and more. BTW, oligopolies are where the greatest profits exist. Think of it. The big firms in American are where the most profits are. 80% of the total profits in business are from Corporations but less that 20% of the businesses are corporations. Corporations can raise capital for big expansion and great research. Intel requires billions of dollars in research every year. No mom and pop store can raise that sort of cash to expand. Marketplace structure matters. I hope this helps you in understanding marketplaces.