AGEC 440 Exam 2

Industry Success definition

"the success of an industry in producing benefits for consumers and producers" - Industry price, profitability, production efficiencies, Ratio of value of sales to cost of marketing goods - E.g. Rate of return in U.S Ag. Industry from 1958-1976 is 0.07

lerners index the part we want to be big is

(P-MC)/P

Under perfect competition; limit number of firms

limit of n approaching ∞: -Mi = -∞; (P-MC)/P = 1/Mi=∞ = 0; (P-MC)/P = 0; P-MC = (0*P); P=MC

basic conditions

market demand elasticity and supply elasticity

residual demand equation

market demand-supply of market Structure: -Mi = -Md*n+-E0(n-1) E0: Elasticity of supply of others

a higher learners index could be grounds for

market power abuse

Increasing concentrations raises issue of

market power and price discrimination practices, prices set at non competitive levels because of monopsonistic power which takes advantages of farmers

REMOTE ENVIRONMENT

(not in 5 forces) • SOCIOCULTURAL TRENDS (gm, red meat, heart attack grill) • TECHNOLOGICAL TRENDS (gm, amazonfresh) • GOVERNMENT/REGULATORY TRENDS (EPA-ex: dairy, entitlement programs) • ECONOMIC TRENDS (income-ex: 10% spent on food)

Farmer conduct: Contracts

- Can limit price risks, can transfer risks from farmers to suppliers - Can diversify price risk away - Can guarantee price and quantity; specify quality

Ag pollution case

- Higher barriers to entry because of government regulation. - Higher concentration because of less firms. - Firms are not big enough to pass on costs to Walmart. - Due to size of Walmart would have a fixed price - Costs go up. Prices stay the same - Concentration isn't a good indicator

questions posed by IO: Is it a Monopolistic competition? - Is it a cartel or oligopoly?

- Is it a Monopolistic competition? • E.g. Life sciences: Monsanto dominant leader - Is it a cartel or oligopoly? • E.g. OPEC, Ag. co-operatives

Deterministic view challenged

- Structure need not unilaterally determine conduct • Firms can change market structure (advertising) - Improvements in understanding of firm conduct: Strategic management

5 attributes of industry structure that threatens the ability of a firm to either maintain or create above normal-economic returns

- Threat of Entry: presence of abnormal returns - Threat of Rivalry - Threat of Substitutes - Threat of Supplier power - Threat of Buyer power 5 forces +1: government an increase in any of these hurts performance

Industry demand

- growth in consumer demand due to say population or income (but a decline in population but disposable income is increasing bc they are spending less on kids) example-chinas demographic crash is a serious issue bc population is decreasing so there will be less people to work but the market is growing because income is increasing. another ex: in spain they get paid an hour off to have sex because population is decreasing

efficiency reasons for M&A

- increasing scale to optimal level - synergies or economies of scope - improvement in management: economies of scale in management ex for merger: if a small company with high costs, merges with a big company, efficiency increases.

Industry supply

- technology with economies of scale

"ethanol plants could make lots of money"

-30% return on investment incentivizes entry -as more competitors enter, price of corn (input) increase and energy cost (propane) increases -lowers profitability -threat of entry

walmart case: strengths

1. Store Formats: Urban, Supercenter, and Int'nl stores (see Exhibit 1) 2. Tech. Development: Cumulative experience with inventory management technology. (e.g. EDI, Retail Link, RFID) 3. Human Capital: Associates embraced vision of low cost and ability to analyze sales data 4. Wal-Mart Int'l Experience: Demonstrates some experience to adapt foreign market conditions (e.g. Brazil). Note: all entrance strategies involve a consistent pattern of initially forming JV or alliances.

synergies or economies of scope formula

TC(Qa,Qb)<TC((Qa+TC(Qb)) which means you can reduce the total cost of producing both products separate if you produce them together

ADM example of concentration

ADM and 3 other Agribusiness are key producers of lysine (key ingredient tin animal feed) that got caught price fixing by raising 40-70%. they agreed that each firm would take a different region so they created a monopoly by region structure: high concentration in animal feed conduct: oligopolistic/cartel pricing

structure-barriers to entry

Barriers to entry may exist due to high fixed cost of entering market created by economies of scale

What is Porter's 5 forces?

Based on SCP framework to assess environmental threats or competitive market conditions https://www.mindtools.com/pages/article/newTMC_08.htm 1. Competitive Rivalry: This looks at the number and strength of your competitors. How many rivals do you have? Who are they, and how does the quality of their products and services compare with yours? 2. Supplier Power: This is determined by how easy it is for your suppliers to increase their prices. How many potential suppliers do you have? How unique is the product or service that they provide, and how expensive would it be to switch from one supplier to another? 3. Buyer Power: Here, you ask yourself how easy it is for buyers to drive your prices down. How many buyers are there, and how big are their orders? How much would it cost them to switch from your products and services to those of a rival? Are your buyers strong enough to dictate terms to you? When you deal with only a few savvy customers, they have more power, but your power increases if you have many customers. 4. Threat of Substitution: This refers to the likelihood of your customers finding a different way of doing what you do. For example, if you supply a unique software product that automates an important process, people may substitute it by doing the process manually or by outsourcing it. A substitution that is easy and cheap to make can weaken your position and threaten your profitability. 5. Threat of New Entry: Your position can be affected by people's ability to enter your market. So, think about how easily this could be done. How easy is it to get a foothold in your industry or market? How much would it cost, and how tightly is your sector regulated?

TASK ENVIRONMENT

INDUSTRY ANALYSIS BASED ON INDUSTRIAL ORGANIZATION ECONOMICS (STRUCTURE-CONDUCT- PERFORMANCE) 5 forces

5 forces came from

IO but before IO it came from military strategy from SunTzu Art of War

What is the SCP framework?

Basic Market Conditions: demand and supply (can be homogeneous, differentiated, etc.) S: Structure (# of firms (buyers/sellers; barriers to entry; factors determining competitiveness of markets) C: Conduct (price setting/price taking, behavior of firms) P: Performance of all firms in the industry (price, profits)

Applications of SCP paradigm

Case: OPEC; two equations; oil/gas has lower n, so would invest in oil/gas

Economies of scope

Cheaper to produce two different products under one firm

Anti-Trust laws increase what?

Competitiveness

walmart case: threats

Competitors: Many rivals have adopted discount concept from (e.g. Home depot, Target, Best Buy, HEB). Given Wal-mart's increasing product scope, these low cost or discount business serves as increasing threats to Wal-mart's core and extended businesses (i.e. electronics). This reduces performance

Lerner Index

Conduct: (P-MC)/P = 1/mi

Barriers to entry

Cost of entry by new firms; scale economies, high fixed cost to switch consumers behaviors, government (tariffs) - mitigates the threat to entry

Economies of Scale

Costs go down as more of the same product is produced

supply elasticity and fixed investment

a larger fixed investment is more inelastic which means a smaller supply elasticity

As mergers and acquisitions lead to greater concentration, M&A, must therefore be anti-competitive. (True or False)

False

Limited Heterogeneity

Firms in the industry are homogeneous - Omits consideration for differences among groups and individual firms • Group level:Food retailing Generic brand vs Premium brand • Firm level: Difference in firm attributes - e.g. Brand loyalty, differentiated product, economies of scale

What causes E0 (elasticity of supply of others) to change?

Fixed costs; higher fixed costs would lead to more inelasticity, there would be less response to price.

Does industry or firm have more variables?

Generally speaking the industry normally accounts for most of the variance approximately 80%

Limitations of SCP approach

Homogeneity: every firm can not produce same amount. Direction of causality: direction of SCP can change (firms can change market structure: advertising) Static-orientation: just a snapshot; not changing industries

Point behind long equation conversion is we can reveal some assumptions like

Homogeneity: no differences in output q=Q/n but this is not always true in the real world so to still use the model you could group together companies with similar outputs

walmart case: weaknesses

Human capital: Poor record of treatment of employees.

Concentration: Meat Packing

Increase concentration occurring because economies of scale

Some Industry motivations for IO

Increase concern for the competitive conditions of agricultural market place - Mergers and Acquisitions • Life science sector: Monsanto under went numerous acquisitions (buying up companies leads to less competitors=few huge players in market bc of this there are concerns for anti trust violations since there are only 2 big players which means buyers could lower prices and suppliers couldnt do anything about it) - Concentration • Hog slaughter industries - Anti-Trust

Concentration: Life Science Sector

Increased concentration because biotechnology; results of Mergers & Acquisitions

Concentration: Grain Processing

Increased concentration because of consolidation of firms, n gets smaller

walmart case: Opportunities

International Growth: Net sales in international segment were up 16.6% with $2 Billion in profit. (Exhibit 3). Larger growth than domestic market.

Some Theoretical motivations for IO (industrial organizational) theory assumes that

Introduces "deviations" from micro- economic theory - limited information - government actions - barriers to entry/exit - transaction costs - firm maximizing behavior

What happens if the elasticity of demand becomes larger?

It would make demand more elastic (more horizontal)

Sun Tzu said that

It's not about actual fighting it's ultimately an intellectual exercise

anti trust laws prohibits M&A that

LESSON COMPETITION E.g. In seed genetics industry Monsonta was to acquire Dekalb genetics which would have made Monsanto a dominant supplier of seed technology

Md

Market demand elasticity; # of substitutes impacts this

Implications of industry not operating at perfect competition?

Monopolistic; problems of concentration. Can lead to anti-trust

example of oligopoly

OPEC oil-need 2/3 vote to get in=barrier to entry. they are also able to set prices so they can be higher prices

Anti-trust considerations

Predatory pricing: lower prices temporarily to drive out competitors. Exclusionary: by refusing to sell to distributors or retailers who handle products of any of its competitors

N impacts

Price increase, and so does number of substitutes

Issues of SCP

Price spread; in the case of Ag pollution. Concentration not a good measure of market power

Questions of interest to SCP approach

Protection of market structure and if it violates laws Why do we care? (strategy standpoint) - We are concerned about performance - SCP becomes relevant explaining opportunities

Theoretically SCP drives

The O In swot

Are all increases in industry concentration (i.e. internal growth or merger & acquisitions) necessarily anti-competitive?

The antitrust laws do not prohibit all increases in concentration. Increases in concentration may occur through internal growth or through mergers. Internal growth is generally thought to be economically beneficial as it most often reflects the success of produced in the market place in attracting and satisfying customers

What happens to residual demand if n becomes larger?

The demand becomes more elastic (more horizontal)

5 forces impacts

The t in swot

Differences to industry assessment from SCP approach

Turns SCP approach upside down. Not protecting competitive prices, just competitors. n is not a precise guide to measure performance

Strategy Perspective

Turns SCP framework "upside down" standpoint of business: we want to protect ourselves and make less competition - It seeks ways to describes attributes of industry that make it less than competitive - To help firms find ways to make above normal economic profits

We want a ______ Lerners Index

We want a BIGGER lerners index for you not for society; society wants a smaller index.

Ex of Sun Tzu relating to pentagon and Obama admin: Pentagon has contracted to build fighter jets would this make us successful in protecting?

Yes ONLY if we have a good strategy but without strategy we will be defeated. Under Obama administration foreign policy with dealing with conflict is been ineffective in defining the enemy, this is bad according to Sun Tzu because you have to know yourself and your enemy or else you will be killed

According to Porter, an industry is best defined by which of the following? a. An industry as the group of firms producing products that are close substitutes for each other b. An industry as the group of firms producing products that are close complements for each other c. An industry consisting of different firms who utilize different inputs or resources d. B and C e. All of the above

a. An industry as the group of firms producing products that are close substitutes for each other

In the case of Walmart (2005), one of the key challenges facing Walmart's entry to Japan is: a. Japanese consumers equate low prices with cheap products b. Implementation of Walmart's business model in to this foreign market c. Incompatible corporate cultures between Walmart and Seiyu d. Seiyu already has an efficient retail distribution system e. None of the above

a. Japanese consumers equate low prices with cheap products

environmental threats are

any organization external to a firm that REDUCES the level of that firm's PERFORMANCE

The Industrial organizational economics approach explains the performance of a. A subset of firms in an industry b. An industry c. A firm d. A vertical or value chain of interconnected industries (i.e. farm to fork) e. Firms that produce different products in an industry

b. An industry

A firm that decides to implement a price, but yet has not been implemented in the industry, is an example of which component of the S-C-P paradigm a. Basic conditions of the market b. Conduct c. Structured d. Performance e. B and D

b. Conduct

The meat packing industry (pork and cattle) has experienced a trend of a. Decreasing concentration due to health concerns b. Increasing concentration due to opportunities to exploit scale economies c. Concentration remained unchanged due to immature markets d. Increasing concentration due to opportunities to exploit scope economies by synergies e. None of the above

b. Increasing concentration due to opportunities to exploit scale economies

Industrial organization economics was a response to which of the following market conditions? a. Markets are increasingly competitive b. Markets are increasingly concentrated c. Markets are increasingly dynamic d. Markets are increasingly differentiated e. Markets are increasingly mature

b. Markets are increasingly concentrated

In the cases of Hardee Shake and BK breakfast sandwich, which of the following market structures best describes the fast food industry a. Perfect competition b. Monopolistic competition c. Oligopoly d. Monopoly e. None of the above

b. Monopolistic competition

Porter 5 forces explains which part of the market environment a. Remote environment b. Task environment c. Social environment d. B and C e. None of the above

b. Task environment

If there are increasing barriers to entry, the number of players in the market will a. Increase and thus driving up market prices b. Increase and thus reducing concentration c. Decrease and thus increasing concentration d. Performance of the incumbent firm will decrease e. A and D

c. Decrease and thus increasing concentration

The high concentration in the life science or input seed industry was due to the following reason(s): a. A contraction in the seed market which led to an exit of input sector firms b. Scale economies in the production of new seed varieties c. M&A resulting from scope economics between biotechnology seed and chemical research d. Consumers resistance to genetically modified grain products e. All of the above

c. M&A resulting from scope economics between biotechnology seed and chemical research

Anti-trust is based on the following philosophy, Anti-trust protects the ______________ process and not the _____________.

competitive; competitors

Structure determines _____________ and thus ______________.

conduct; performance

In the notes titled, "IO approach to Ag", which of the following best describes the "Conduct" of farmers? a. Increasing reliance on markets prices for the coordination of production activities b. Increasing use of contracts c. Increasing use of contracts by smaller farmers to meet the needs of niche markets d. Increasing use of contracts by larger farmers e. Increasing ability to set higher prices

d. Increasing use of contracts by larger farmers

In the case of Walmart (2005). Walmart's entrance into Germany was not successful for which of the following reasons: a. Incompatible culture b. Strength of trade unions c. German consumers were unfamiliar with the Walmart brand d. Real estate in Germany was too high and thus incompatible to the Walmart business model e. A and B

e. A and B

In the case of Walmart (2005), which one of the following is not considered a competitive advantage? a. Number of stores b. Low cost culture c. Radio frequency Identification (RFID) d. International experience e. Low prices

e. Low prices

meat packing, grain processing and life sciences sector all experiencing high CR4 bc

economies of scale negative returns so small players left M&A due to complimentary relationships

what is the effect of govt regulation on air pollution in the dairy industry's SCP? assume fluid milk prices remain fairly constant

ex in california agriculture cases argues that cows need to be taxed like cars bc of pollution. if this tax goes through, effect on structure: a lot of small producers leave industry, # of players decrease conduct: prices increase, learners increase performance: increases in theory but we know in reality performance would decrease because they can't actually increase price so really you can't just look at structure to figure out the whole story

increased concern about concentration of buyer power

ex: if you're a cattle rancher you'd be concerned that CR4 ratio is increasing because that means there are only a few major players so Price decreases

Ag. Contracts are arrangements under which

farmers agree to deliver products of a specified QUALITY and QUANTITY to a contractor at SPECIFIED times

example of monopolistic competition

fast food burger places-products are slightly different but still competitive. they differentiate based on fat content/calories -ex: burger king breakfast sandwich vs carls jr. shake another ex: heart attack grill-monopolistic competition seems to generate more money but do they have the moral right to serve?

market demand elasticity and substitutes

fewer substitutes=inelastic, closer to 0 a lot of substitutes=elastic, closer to 1

structure-Barriers to entry and economies of scale can lead to

high concentration of sellers - Monopolist/Oligopolistic

Low barriers to entry directly ____________ (increases / decrease) the threat of entry and thus ___________ (increasing / decreasing) industry performance.

increases; decreases

SCP explains performance of

industry, not firm

Performance is trying to maximize

is trying to maximize your own objective • Prices set at non-competitive levels - High average industry profits, - Higher prices > competitive levels, - Non allocative efficient (resources not employed to most efficient use) - High average rates of returns

How does an increase in threats in an industry effect performance?

it decreases performance

Higher barriers to entry gives...?

more sustainable profits

the larger _____ the more performance moves to ____

n ; 0 the more competitive=more firms and performance gets closer to 0

in 5 forces the threat component in SWOT argues

n is too coarse of a measure so you have to blow up n into 5 threats

Structure is defined by

number of buyers and seller

proof for learners index is a measure

of conduct for price setting behavior

example of pepsi at A&M

pepsi has an agreement that A&M can only sell pepsi, not coke but this is NOT a violation of anti trust because it did not leave pepsi to become a monopolist

anti trust laws prohibits use of

predatory and/or exclusionary conduct to acquire or maintain a monopoly / monopsonist position E.g. a food manufacturer that prevents a food retailer from stocking competing products so as to achieve a monopoly position ex: they should be subject to anti trust violations only if they do something like air canada where they drove out the cheap airlines by char gins less than that airline then once the cheap airlines went out of business they raised their prices back up=predatory conduct

______ measures performance

price spread

3 antitrust laws

prohibit collusion (conspiracies to deny market access or suppress competition), predatory pricing, M&As that lessen competition all 3 protect competitive process to maximize social welfare

monopsonist means

single buyer

how ADM can make more barriers to entry

supply more making q* smaller to make a new firms average cost increase

Concentration is measured by: CR4 ratio:

the % share of the market by the top 4 firms

from learners index: (P-MC)/P and starbucks

the elasticity is small so (P-MC)/P gets bigger so they can set high prices

walmart problem statement

the problem statement needs to explicitly account for growth strategies that directly account for its strengths (as well as its weaknesses) Given Walmart's strengths / weaknesses in discount retailing as well recent changes in the competitive landscape, how can Wal-mart maintain its strategy of growth, ESPECIALLY with respect to Walmart choice's of product scope, store type, and international growth?

Increasing plant size with corresponding decreases in number of plants means

they are achieving economies of scales, since plants are increasing in size this increases the numerator in CR4, if players leave market this decreases denominator

ex of monsanto getting into seed industry

they started as ag chemicals but saw opportunity in GMO so they started buying up seed companies Higher concentration not necessarily attributed to economies of scale but oriented around exploiting complementary relationships

price spread formula

wholesale price-live cattle price basically price spread is approximately equal to the learners

2 Purposes of 5 Forces

• Assist firm manager's framework to analyze environmental threats • To develop strategies to neutralize threats so as to seek competitive advantage (Competitive advantage yields above normal economic returns) AKA minimize competition by getting to know your threats

3 Benefits of Contracting

• Farmers transfer some of the price risk to processors (Processors have diversified portfolios and thus better able to bear risk, processors want to take on risk because they always want to run at full capacity) • Contracting allows processors steady flow of products (improve capacity utilization and reducing processing costs) • Incentive to produce higher and more consistent product quality to satisfy demand i.e. you can write in contract what kind of quality you want

industry Dissaggregation

• Industry definition can be further diss-aggregated (means separated based on sectors) based on similarity - e.g. livestock, grains and crops, fruits and vegetables • Further diss-aggregation - e.g. Canadian corn farming: Industry comprising of establishments growing corn 11115 • Analysis of industry performance depends on level of dissaggregation

SCP Limitations

• Limited Heterogeneity: Firms in the industry are homogeneous • Deterministic view challenged • static view (assumes stable industry structure) also to explain performance you have to look at structure bc arrow only go one way. ex: if SCP is true then your performance as a manager is not because you did well its because the structure let you do well

Conduct

• Monopolist/oligopoloist charge prices above Marginal cost - E.g. price fixing: setting higher than normal competitive prices - prices determined by inelastic demand and shifts in demand conditions

Definition of an Industry

• Porter defines as "an industry as the group of firms producing products that are CLOSE substitutes for each other" (1980) - e.g. Agricultural industry: all firms that produce some type of live product

Questions of market organization/structure challenges perfect competitive conditions:

• Price taking behavior - e.g. Monsanto charges licensing fees for seed • Free entry/exit - e.g. high fixed investment in meat slaughter facilities