Students should be able to: Understand the characteristics of this market structure with particular reference to the interdependence of firms Explain the behaviour of firms in this market structure Explain reasons for collusive and non-collusive behaviour Evaluate the reasons why firms may wish to pursue both overt and tacit collusion

1. How does the threat of competition
affect a firm’s behaviour?
Topic 3.3.10

2. How does the threat of competition
affect a firm’s behaviour?
Topic 3.3.10
Students should be able to:
• Define contestability and understand how the threat of new
entry may influence behaviour and market performance of
existing firms.
• Understand the relationship between sunk costs and the
degree of contestability — examples may include banking,
airline industry and petrol retailing.

3. • Contestable markets are constantly changing!
• Can be seen at a local, regional, national and
international level
• In a contestable market, the number of firms & the size
distribution of firms is not considered to be important
• More focus given to credible threat of entry from rivals
• Almost all markets are contestable to some degree
• Technology is changing contestability
– E.g. Barriers to entry have lowered because of digital advances
– Many start-ups use the web as a platform to enter markets
• Contestable markets often show high dynamic efficiency
– challenger brands attacking established operators
Contestable Markets

4. Some Contestable Markets In Action
Peer to Peer
Lending
Fast Food
Industry
Hotel / Room
Sharing Sector
City Transport
Services
Private
Education
Bookselling

5. Netflix and Global Expansion

6. Netflix Annual Revenue ($ million)
0
1000
2000
3000
4000
5000
6000
7000
8000
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
RevenueinmillionU.S.dollars

7. Netflix and Global Expansion
Amount of content available on Netflix in selected countries as of January 2016, by content type
All videos Movies Series
Argentina 3,511 2,847 664
Australia 2,081 1,623 458
Brazil 3,538 2,956 582
Canada 3,517 2,870 647
Chile 3,505 2,847 658
Cuba 3,040 2,425 615
France 1,906 1,510 396
Germany 1,816 1,451 365
India 774 563 211
Indonesia 715 529 186
Ireland 2,966 2,411 555
Japan 1,786 1,376 410
Mexico 3,525 2,869 656
New Zealand 2,034 1,581 453
Nigeria 702 493 209
Russia 753 542 211
South Korea 691 525 166
Spain 1,305 1,061 244
Switzerland 2,180 1,736 444
United Arab Emirates 643 465 178
United Kingdom 2,973 2,414 559
United States 5,680 4,566 114

8. Peer to Peer Lending (Funding Circle)

9. Peer to Peer Lending (Funding Circle)
0
50000000
100000000
150000000
200000000
250000000
300000000
350000000
400000000
450000000
2010 2011 2012 2013 2014 2015
Amountofmoneylentin£s
0.1%0.3%
2%
9%
27% 27%
19%
9%
4%
3%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
1-2 2-3 3-4 4-5 5-6 6-7 7-8 8-9 9-10 10+
Shareofinvestors
Investor return after fees and bad debts

10. Airbnb

11. Airbnb
10
25.5
0.8
2.3
0
5
10
15
20
25
30
2014 2015*
ValueinbillionU.S.dollars
Company valuation Total equity funding

12. Hotel rooms & Airbnb listings in New York
94,235
97,400 99,250
6,585
10,963 12,446
0
20000
40000
60000
80000
100000
120000
2012 2013 2014*
Numberofavailablerooms
Hotel rooms Airbnb listings

13. Absence of sunk costs
Access to all available
technology
Low rate of existing
consumer loyalty Low barriers to entry
1. A pool of new
entrants who are
willing and ready to
enter the market –
e.g. app developers
2. No significant entry
or exit costs – lowers
the risk of market
entry
3. Equal access to
available industry
platform
technologies
4. High rates of
customer churn
(switching)
Key Conditions for a Contestable Market

14. Examples of Disruptive Businesses
Disruptive Businesses,Top Innovators, Disruptive Business Models
A: Air BNB, Aldi, Alibaba, Avant
B: Bitcoin, Bloom Energy, Buzz Feed, BookIndy
C: CrowdCube, Coursera, Cahoot, Car Trawler, CoinJar
D: Dropbox, Dollar Shave, Deliveroo
E: Eventbrite
F: First Utility, Funding Circle
G Google, GetAround
H: Huawei
I: Instagram
J: Jawbone, Just Eat
K: Kickstarter, King of Shaves
L: Lyft, Lidl
M: Mozilla, Metro Bank
N: Netflix, Nest

15. Examples of Disruptive Businesses
O: Osper, Oppo
P: Pinterest, Periscope
Q: Quirky
R: Rent the Runway, RyanAir, Rinse
S: Shazam, Samsung, Snapchat, Space X
T: Tesla, Twitter, Trip Advisor, Tata
U: Uber
V: Vine, Viber
W:What’s App, Wikpedia
X: Xiaomi
Y: Yo Sushi, Yelp, YPlan, Yik Yak
Z: Zipcar, Zoopla, Zynga

16. Contestable Markets in Action!
• Jan 2016: Netflix announces their streaming service is now
available in 130 countries.
• Nov 2015: Apple 'to launch peer-to-peer payment app' in
competition with PayPal
• Nov 2015: Gym Group, one of the UK's low-cost fitness
chains goes for listing on stock market to fund future
expansion
• Nov 2015: Uber taxi app set to launch in Edinburgh
• Nov 2015: Amazon announces the opening of their first
physical “bricks and mortar” bookstore
• Oct 2015: Metro Bank Takes Step Towards £1bn Listing
• Oct 2015: Sainsbury's tests out 'micro-stores' for busy
shoppers

17. Contestability and Dynamic Efficiency
• Dec 2015: Porsche to make electric sports car in €700m
project - aimed at challenging Tesla's dominance of the
battery-powered sports car market
• Dec 2015: Ford says it will invest $4.5bn (£3bn) to
expand its fleet of plug-in and hybrid electric vehicles,
and will start selling 13 new electric models by 2020.
• Nov 2015: Huawei reveals a new quick-charge battery
• Nov 2015: The doctor will text you now: Will mobile
devices change healthcare? – new app allows doctors to
process their patients electronically and remotely

18. Leading global generic drug manufacturers by market share 2013
Top 10 generic drug manufacturers - worldwide market share in 2013
Note: Worldwide
13.4%
11.9%
9.1%
8.6%
4%
3.9%
3.5%
3.2%
3.1%
2.5%
0.0% 5.0% 10.0% 15.0%
Teva Pharmacetical
Novartis
Actavis
Mylan
Aspen Pharmacare
Sun Pharmaceutical
Hospira
Daiichi Sankyo
Sanofi
Lupin
Market share
Each medicine has an approved
name called the generic name. For
example, paracetamol is a generic
name. There are several companies
that make this with brand names
such as Panadol®, Calpol®
Generic Drugs and Contestability

19. Market share of mobile handset manufacturers in the UK in June 2014
31.8%
22.9%
16.9%
6.7% 6.1%
3.7%
2.4% 2.1%
7.4%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
Samsung Apple Nokia Sony HTC RIM Motorola LG Other
MarketshareA Contestable Oligopoly?
The 5 firm concentration ratio
= 84.4% - but this is a highly
competitive market!

20. Sunk Costs
1. Sunk costs cannot be recovered if a firm leaves
an industry
2. When sunk costs are high then a market
becomes less contestable
3. High sunk costs act as a barrier to entry of new
firms because they risk making significant losses
if they decide to exit the sector
4. In markets such as fast-food restaurants,
sandwich bars, hairdressing salons and local
antiques markets there are low sunk costs so
barriers to exit are low and contestability is high

21. Core Examples of Sunk Costs
1. Asset-write-offs – e.g. writing-off the value of plant and
machinery, stocks and the goodwill of a consumer brand
2. Closure or project cancellation costs including redundancy
costs, bad debts, contracts with suppliers and the penalty
costs from ending leases for property & equipment
3. The loss of business reputation and goodwill - a decision to
leave a market can seriously affect goodwill among previous
customers, not least those who have bought a product which
is then withdrawn and for which replacement parts become
difficult or impossible to obtain.
• A market downturn may be perceived as temporary and
could be overcome if and when the economic or business cycle
turns and conditions become more favourable

22. Asset write-offs Lost consumer goodwill
Redundancy costs
Exit Costs – Barriers to Exit

23. Internal economies
of scale
Vertical integration
Strength of customer
brand loyalty
Control of important
technologies
Expertise and
reputation
Key Barriers to Market Contestability

24. Deregulation of an industry Open up networks of monopolies
Tough rules on predatory pricing Encouraging international trade
Policies to Increase Contestability

25. Key Concepts – Contestable Markets
Key concept Brief definition
Contestable Market
Where an entrant has access to all
production techniques available to
incumbents and entry decisions can be
reversed without cost
Hit and run entry
When a business enters an industry to
take advantage of temporarily high
(supernormal) market profits.
Sunk costs
Sunk costs cannot be recovered if a
business decides to leave an industry.
The existence of sunk costs makes a
market less contestable.

26. • Lidl is following a strategy of rapid organic growth
• Aldi - world’s leading limited assortment grocery, with
total sales of €61bn in 2013, followed by Lidl at €59bn
• Together, the two German discounters have more than
20,000 stores across Europe, the US and Australia. Lidl
is present in 26 European markets
• Majority of their products are own-label, rather than
brands - gives them purchasing power with suppliers.
• The range suppliers are asked to provide is narrower –
perhaps four to six products compared with 30-40 at a
large grocer – driving efficiencies and big volumes
Retail Contestability – Rise of Aldi & Lidl

27. Contestable Markets – Price and Profit
• The more contestable a market is, the more likely
that an allocatively efficient outcome is achieved
• The threat of entry affects the behaviour of firms
• Often smaller disruptive businesses challenge the
monopoly power of existing businesses
• The threat of entry is as important as actual
competition

28. Cost & Price
Output (Q)
Highly Contestable Market –
Profit Maximising Output
AC
AR
MR
MC
In the left hand
diagram draw in
the profit
maximising output
and price (label it
Q1 and P1.)
Q1
P1
C1
Price > Average Cost
Supernormal profits
High profits send
signals to other
suppliers
Pricing – Options in Contestable Markets

29. Cost & Price
Output (Q)
Highly Contestable Market –
Profit Maximising Output
AC
AR
MR
MC
In the long run if
the market is highly
contestable which
level of price and
output is probable?
Q1
P1
C1
When AC = AR,
normal profits made,
a return sufficient to
keep factor inputs in
their present use
P2
Q2
Pricing – Possible Long Run Equilibrium?

30. Cost & Price
Output (Q)
Highly Contestable Market –
Pricing to Maximise Revenue
AC
AR
MR
MC
In the right hand
diagram show the
price and output
for a firm that
seeks to maximise
total revenue
Pricing – Maximising Revenue

31. Cost & Price
Output (Q)
Highly Contestable Market –
Pricing to Maximise Revenue
AC
AR
MR
MC
In the right hand
diagram show the
price and output
for a firm that
seeks to maximise
total revenue
P1
Revenue maximised
when marginal
revenue = zero
Pricing – Revenue Maximisation

32. Cost & Price
Output (Q)
Highly Contestable Market –
Pricing to Maximise Revenue
AC
AR
MR
MC
In the right hand
diagram show the
price and output
for a firm that
seeks to maximise
total revenue
P1
C1
Revenue maximised
when marginal
revenue = zero
Still some super
normal profits made
Lower price and
higher output than
MC=MR
Revenue max means
a lower profit margin
is made – usually
good for consumer
welfare – but profit
has value too!
Pricing – Revenue Max – Lower Profits

33. • The threat of new competition is often a
powerful an influence on the behaviour of
existing established firms
• A highly contestable market will resemble perfect
competition, regardless of the number of firms,
since incumbents behave as if there were intense
competition!
• Competition policies that help to open up the
market to new suppliers or persuade consumers
to switch in greater numbers help to increase
contestability
Contestable Markets – Evaluation Points

34. How does the threat of competition
affect a firm’s behaviour?
Topic 3.3.10