Businesses compete differently in different types of markets. Pricing decisions in a competitive environment mainly depend on the level of competition in the market.
Let’s take a look at the types of competition in three different types of markets.
Competition in a perfectly competitive market
Competition in this market is the most extreme form of competition.
All businesses in a perfectly competitive market are price takers. That means that they all must charge the market price. If they try to set a price higher than this, then they will sell nothing. If a business was to charge a higher price than its competitors, it is likely that consumers will not buy their product because they can get similar for cheaper.
The conditions for perfect competition are so strict that very few, if any, industries come close to it. Four specific conditions must be met for this type of market to exist:
- Knowledgeable customers. Consumers have perfect knowledge about products, prices, etc., hence companies must accept world market prices.
- Homogenous products. Firms’ products are homogeneous. All products are virtually indistinguishable from those of other companies when it comes to quality, features, etc.
- No barriers to entry. It is relatively easy to join this industry because there is freedom of entry into and exit from the market.
- Firms of similar size. There are many consumers and producers, but none of them is big enough to influence prices on its own.
Small businesses in the perfectly competitive market are more likely to have to adopt competition-based pricing methods such as competitive pricing, price leadership and predatory pricing (destroyer pricing). The greater the competition in a market, the lower prices will be.
Competition in an oligopolistic market
Competition in this market is the medium extreme form of competition.
Oligopolistic markets are dominated by just a few large firms. It is common in industries that require massive amounts of capital investment in equipment, research and development or advertising. As only a few large firms are able to afford these expenses, they are able to dominate the market in the end.
Examples of oligopolies include oilfield services (Schlumberger, Halliburton, EOG Resources, Canadian Natural Resources, Enterprise Products Partners, Enbridge, Occidental Petroleum, ENI, Petróleo Brasileiro S.A. – Petrobras, Pioneer Natural Resources, and Marathon Petroleum (MPC)), integrated energy oil and gas (Exxon Mobil, Chevron, Royal Dutch Shell, BP, Conoco Phillips, Total Energies), tire production (Michelin, Bridgestone, Goodyear, Continental, Pirelli) or soft drinks (The Coca-Coca Company, PepsiCo, Keurig Dr Pepper, The Dr Pepper Snapple Group, Suntory Beverage & Food).
In nearly all oligopolistic industries, these firms compete with each other in one of the following ways:
- Price competition. This mainly includes price wars. While they can help gain market share, they can be damaging to profits, or lead to some weaker firms being forced out of the industry. If completion in the industry is reduced in the long-term, it might lead to higher prices eventually and less new products as the need to innovate will be reduced.
- Non-price competition. This mainly includes promotional campaigns. If oligopolies do not wish face the potentially unprofitable effect of price wars, they will engage in fierce and competitive promotional campaigns which are designed to establish strong brand identity leading to market dominance.
- Collusion. As both of the forms of competition referred to above are expensive and may reduce profits, colluding with one another to form a cartel is fairly ‘easy and cheap’. Collusion is a secret or illegal cooperation or conspiracy, especially in order to cheat or deceive others. In the context of business, collusion occurs when two or more businesses agree to work together to fix prices, divide up markets, or otherwise restrict competition. Because collusion is illegal in many countries, business will be subject to serious court action and heavy fines when discovered.
Competition in a monopolistic market
Competition in this market is the least extreme form of competition.
There is usually one company in this market – a monopolist – which is a single seller of a good or service. This one business in a monopolistic market is a price maker. It does not have to take the market price from anyone else, because it sets it by itself exploiting its dominant position.
Typically, it is very difficult, if not impossible, for other firms to join the industry due to high barriers to entry including:
- High costs. Huge costs of becoming established on the market, e.g. building nuclear power plants.
- Technology. The need to invent or acquire necessary technical knowledge and skills, e.g. constructing an aircraft or space rocket.
- Legal control. The activities of these firms are often limited by government controls, e.g. acquiring patents to produce medication.
- Infrastructure. Services that would support only one provider, e.g. setting up pipelines for water-supply companies.
Big businesses in the monopolistic market are less likely to have to adopt competition-based pricing methods such as competitive pricing, price leadership and predatory pricing (destroyer pricing). The lesser the competition in a market, the higher the prices will be.
In summary, Remember that the easier it is for new firms to join an industry, the more competitive market conditions are likely to be. And, the harder it is for new firms to join an industry, the less competitive market conditions are likely to be.
