g explain the effects of barriers to entry, industry concentration, industry capacity, and market share stability on pricing power and return on capital; Flashcards Preview

L1 50 Introduction to Industry and Company Analysis > g explain the effects of barriers to entry, industry concentration, industry capacity, and market share stability on pricing power and return on capital; > Flashcards

Flashcards in g explain the effects of barriers to entry, industry concentration, industry capacity, and market share stability on pricing power and return on capital; Deck (11)
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1
Q

High barriers to entry prevent new competitors from taking away market share, but they do not guarantee pricing power or high return on capital, especially if the products are undifferentiated or barriers to exit result in overcapacity. Barriers to entry may change over time.

A

Ease of Entry
– High barriers to entry benefit existing industry firms
– With low barriers, firms have little pricing power
• High barriers to entry do not necessarily mean firm pricing power is
high (high barriers to exit, fixed cost structure other determinants)

2
Q

While market fragmentation usually results in strong competition and low return on capital, high industry concentration may not guarantee pricing power. If industry products are undifferentiated, consumers will switch to the cheapest producer. Overcapacity may result in price wars.

A

Absolute market share may not matter as much as a firm’s market
share relative to its competitors
– 20% share when all other have less than 2% has great power
– 20% share with three other 20% participants may have little power

Differentiation vs. undifferentiated
• Importance of price to consumer
• For capital intensive (costly to enter or exit), overcapacity can result in
intense price competition

3
Q

Capacity is fixed in the short run and variable in the long run. Undercapacity typically results in pricing power. Producers may overinvest in new capacity, especially in cyclical industries or if the capacity is physical and specialized. Non-physical capacity comes into production and can be reallocated more quickly than physical capacity.

A

Capacity
– Industry capacity has a clear impact on pricing power
– Capacity is fixed in the short run and variable in the long run

4
Q

Highly variable market shares indicate a highly competitive industry. Stable market shares suggest less intense competition. High switching costs contribute to market share stability.

A

Market Share Stability
– Highly variable likely indicates competitive industry and little
pricing power
– More stable indicates less intense competition in the industry

Factors that affect market share stability
– Barriers to entry
– Introductions of new products and innovations
– Switching costs

5
Q

A firm is most likely to have pricing power if it operates in an industry characterized by high concentration, undercapacity, and high market share stability

A

Firms in highly concentrated industries are more likely to have pricing power than firms in fragmented industries. Firms in industries with tight capacity constraints are more likely to have pricing power than firms in industries with excess capacity. High market share stability is indicative of pricing power because competition is likely less intensive.

6
Q

Pricing power for the firms in an industry is most likely to result from low:levels of capacity.

A

Low capacity is associated with pricing power because it increases the likelihood that supply in the short run will be less than demand at current prices. Low barriers to entry and low industry concentration (a fragmented market) typically suggest firms have little pricing power.

7
Q

Which of the following conditions is most likely to indicate that barriers to entry into an industry are low?: Investment capital is available at low cost.

A

Readily available capital tends to make entry into an industry easier. If an industry is composed of the same firms over a long period of time, barriers to entry are likely high. Economies of scale are a barrier to entry because existing firms are likely to be producing at a lower cost per unit than a new competitor can achieve.

8
Q

Market share stability within an industry is least likely to result from a high level of: Product Innovation

A

Frequent introductions of new products and innovations tend to make firms’ market shares within an industry less stable. High barriers to entry into the industry and high switching costs for customers to change to a competing product both contribute to market share stability.

9
Q

A firm is most likely to have pricing power if: Its product is differentiated

A

Firms offering products that are differentiated in terms of quality and features are more likely to have pricing power than firms that produce undifferentiated (commodity-like) products. High market share does not necessarily imply pricing power; for example, if four firms each have 25% market share, none of them are likely to have significant pricing power. High exit costs can create overcapacity in an industry and result in a high degree of price competition as firms try to maintain production volume during a period of reduced demand.

10
Q

Which of the following statements about switching costs is most accurate? Switching costs include the time needed to learn to use a competitor’s product.

A

Switching costs include the time and expense of learning to use a competitor’s product and tend to be higher for specialized or differentiated products. High switching costs contribute to market share stability and pricing power.

11
Q

Explain the effects of industry concentration, ease of entry,
and capacity on return on invested capital and pricing power

A

• Capacity
– Industry capacity has a clear impact on pricing power
– Capacity is fixed in the short run and variable in the long run
• Market Share Stability
– Highly variable likely indicates competitive industry and little
pricing power
– More stable indicates less intense competition in the industry
• Factors that affect market share stability
– Barriers to entry
– Introductions of new products and innovations
– Switching costs

Decks in L1 50 Introduction to Industry and Company Analysis Class (11):