Structure Conduct & Performance
The structure-conduct-performance (SCP) paradigm has played an important role in industrial
organisation research since the pioneering work of Mason (1939). He and his colleagues
examine in depth the relationships between various structure and performance variables for a
large number of industries. The basic idea is that market structure determines the conduct
(strategy) of firms which in turn determines the performance of industries
It was developed in 1959 by Joe S. Bain Jr., who described it in his book “Industrial Organization”. The SCP paradigm is considered a pillar of industrial organization theory, and it has been since its conception a starting point when analysing markets and industries, not only in Economics but also in the fields of business management and controlling (Business Environment).
A market is a set of buyers and sellers, commonly referred to as agents, who through their interaction, both real and potential, determine the price of a good, or a set of goods. The concept of a market structure is therefore understood as those characteristics of a market that influence the behavior and results of the firms working in that market. (Market structure refers to a description of a market in terms of the number and the size distribution of the firms and any entry barriers arising from the technology of production. Market structure depends on the basic conditions of demand and supply. Demand conditions include direct and cross elasticity of demand, market growth and the purchasing power of the customers. Supply conditions include location and ownership of raw material, technology, unionisation, product durability, industry history and the legal, ethical and political framework within which business activities take place. Under the heading of market structure, the following characteristics can be listed: concentration, diversification, product differentiation, barriers to entry and scale economies)
The main aspects that determine market structures are:
- the number of agents in the market, both sellers and buyers;
- their relative negotiation strength, in terms of ability to set prices;
- the degree of concentration among them;
- the degree of differentiation and uniqueness of products;
- and the ease, or not, of entering and exiting the market.
The interaction and differences between these aspects allow for the existence of several market structures, from which we can highlight the following:
- Perfect Competition
- Monopolistic Competition
Perfect competition or competitive markets -also referred to as pure, or free competition-, expresses the idea of the combination of a wide range of firms, which freely enter or leave the market. Characteristics of Perfect Competition are
- Homogeneous product: all firms offer the same goods, with the same characteristics and quality as the others, without any variations.
- Large number of agents: there should be a sufficient quantity of buyers and sellers so that no action from a single agent will affect the market structure or its prices.
- No entry or exit barriers: there has to be free entry and exit of agents in the market. This assumption is of special interest for firms, which must be able to enter or leave the market freely.
- Firms under perfect competition are price takers.
- Price flexibility: price adjustments to changes happen as fast as possible. Usually, price changes are assumed instantaneous.
This market is formed by a high number of firms which produce a similar good that can be seen as unique due to differentiation, that will allow prices to be held up higher than marginal costs. Monopolistic competition is a market structure defined by four main characteristics:
- large numbers of buyers and sellers;
- perfect information;
- low entry and exit barriers;
- similar but differentiated goods. (seller tries to differentiate their products through unique size, location, branding, packaging, additional features, etc.)
- Firms under monopolistic competition are price makers.
This last one is key to distinguish monopolistic competition from perfect competition since in the latter all products are homogenous. This product differentiation leads consumers to perceive products in this market as unique, providing firms with a monopolistic-like property that enables them to have price-making power.
Oligopoly is a form of market structure that is considered as halfway between two extremes: perfect competition and monopolies. This kind of imperfect competition is characterized by having a relatively scarce amount of firms, but always more than one, which produces a homogeneous good. Due to the small number of firms in the market, the strategies between firms will be interdependent, thus implying that the profits of an oligopolistic firm will highly depend on their competitors’ actions.
- Few sellers and a large number of buyers. Much of the market concentration is enjoyed by few firms. Interdependence is very high in oligopoly market. Seller has to be highly cautious in respect to any action taken by its competitors.
- High barrier of entry and exit
- Can be both differentiated or identical products
- Firms under oligopoly are price makers but constrained by the pricing strategy of competitor
Monopoly is a form of market structure of imperfect competition, mainly characterized by the existence of a sole seller and many buyers. This kind of market is normally associated with entry and exit barriers.
All of these features give the monopolist the ability to set prices with the only limitation of consumers’ willingness to pay. Therefore, in monopolies, the seller is a price-maker and consumers will be price-takers. The firm will choose its production output (q) and price (p) in order to maximise revenue (π). The optimal condition, where we’ll have marginal cost (MC) equals marginal revenue (MR), is given by:
Monopolistic firms maximise their profits with the level of output in which marginal cost equals marginal revenue.
- One seller and many buyers. Market fully concentrated on the seller. As a result, sellers have full influence on price and market
- High barrier to entry and exit the market. Can use both natural and artificial barriers
- No identical product is available at the market
- Firms under monopoly are price maker
The way in which buyers and sellers behave, both amongst themselves, and amongst each other. Firms choose their own strategic behavior, investment in research, in development, advertising levels, collusions, etc. (Firm conduct includes the decision of firms on pricing, the way in which the volume, quality and range of products are determined, research and development planning,
implementation and legal tactics, the decision by the firms whether to collude or compete. One
effect of the conduct may be to change the industry structure in terms of the market
concentration or entry barriers. However, the main importance of conduct is that it provides
the link between structure and performance.)
Some types of conduct behavior are:
- Business objectives- short run/long run; profit maximization; total revenue maximization; growing market share; etc.
- Pricing policies- collusive pricing; predatory pricing; price discrimination; price leadership; etc.
- Research and development/ advertisement/ branding- how much to invest?
- Collusion- forming collusion to dictate the market price
- Merger and acquisition- horizontal/ vertical integration; geographic mergers; strategic mergers; etc.
It is measured by comparing the results of firms along with the industry in efficiency terms, and different ratios are used to assess different profitability levels. The variables considered at this level are such as product quantity, product quality, resource allocation, production efficiency, etc. (Industry performance in its most general sense is an evaluation of the contribution of the industry as a whole to economic welfare. A typical list of performance indicators includes allocative efficiency, equity, employment creation, X-efficiency, technological progressiveness and quality of output. In practical terms, performance refers primarily to profitability, a measure related to allocative efficiency.)
The dynamic behaviour of buyers and sellers have an effect on the markets, making it harder to predict and establish fixed market structures. Difficulties arise when trying to explain the paradigm and this is due to data shortage, and the multiple definitions and extension of markets. Actually, the main problem when using this methodology to analyse a market or industry is the difficulty of defining the limits or boundaries of a given industry.
Relationship and structure of the SCP model (Wirth & Bloch, 1995).
Questions for Practice:
- How do the points mentioned below affect the STRUCTURE of the market? Give examples.
- Product Differentiation
- Vertical integration in the industry/market
- The degree of Diversification of firms in a market
- How do the points mentioned below affect the CONDUCT of a firm in the market? Give examples.
- Business objectives
- Pricing policies
- Product design, branding, advertising & marketing Research & Development (R&D)
- Mergers & Acquisitions
- How do the points mentioned below affect the PERFORMANCE of a firm in the market? Give examples.
- Quality of products/services produced Technological change
- Productive & Allocative efficiency