The Four Industry Types
Firms and their competitors make up the industries in which they operate, and participate in the markets in which they sell their products and services.
These industries and markets can be grouped into four major categories:
1
Perfect Competition
2
Differentiated Competition
3
Oligopoly
4
Monopoly
Factors Influencing Each Industry Type
Each industry type of industry has its own characteristics in terms of three factors:
- the number of independently owned firms operating in an industry
- the type of product or service being sold, and
- the barriers to entry.
These factors further have implications on the degree of price competition, and the types of competition firms choose to compete with their competitors.
Industry Type 1: Perfect Competition
The most competitive industry is one of perfect competition. It is characterized by hundreds to thousands of, on average, small firms selling homogenous products (also called standardized or generic products), such as vegetables.
The consumer does not care who produces the product, since the product from one supplier is the same as the product from another supplier. This means that if a supplier tries to raise prices, the consumer has no reason to pay the higher price, since the same product can be purchased cheaper from another supplier.
The result is that firms in a perfectly competitive industry have no pricing power, and the price for a product is determined by supply and demand. It also means that the only way companies can compete is based on price.
The barriers to enter this type of industry are very low, making it very easy for new entrants to enter the market and compete against the already very large number of firms.
Industry Type 2: Differentiated Competition
The second most competitive industry structure is called differentiated competition (also called monopolistic competition).
The number of firms is lower, and the average firm size larger, than in a perfectly competitive industry.
Importantly, the types of products sold in a differentiated competition industry differs from firm to firm. Each firm produces its own version of the product, with significant differences between competitors. Therefore, they are called differentiated or heterogeneous products.
Product differentiation can take many forms, including design differences, features, specifications, look, real or perceived quality, durability, easy of use, low failure rate, reputation of the firm, after-sales service, location and accessibility, warranty, financing options, service contracts, advertising, marketing, and more.
Product differentiation provides additional value to the customer, increasing their willingness to pay a higher price for getting something better than the competition can offer, therefore giving the firms providing the differentiated products a degree of pricing power, and leads to higher barriers for new firms to enter the industry and compete against existing firms.
Besides competing via product differentiation, firms in differentiated competition industries also compete based on price and promotional strategies.
Industry Type 3: Oligopoly
An oligopoly is characterized by a few, large firms capturing the majority of the market share in an industry.
Firms in an oligopoly either produce standardized products (natural oligopoly), or differentiated products (differentiated oligopoly).
The small number of major companies in an oligopoly results in a rivalry between the firms, rather than impersonal competition, as is the case in industries of perfect and differentiated competition. In an oligopoly, the actions of one firms directly affect the actions of the few other firms.
The barriers to entry into an oligopolistic industry are high, and the price competition is low. This gives firms in a monopoly significant market power, meaning the firms can decide on market prices, rather than having supply and demand dictate them.
Since only a few major players dominate the industry, competition between firms takes the form of a rivalry, rather than impersonal competition, as is the case in industries of perfect and differentiated competition. In an oligopoly, the actions of one firms directly affect the actions of the other few firms.
Firms in an oligopoly try to avoid competing on price. If a firm in an oligopoly tries to steal market share by lowering the prices of its products, the competitor firms have to lower the price as well to not lose customers. This leads to a price war, and in the end none of the companies win.
Instead of competing on price, companies in an oligopolistic industry focus on (1) promotional, (2) product, and (3) strategic competition.
The degree to which an industry is considered oligopolistic can be measured by the concentration ratio, which measures the percent of total sales of the four larges companies compared to the industry’s total sales. The higher the concentration ratio, the more concentrated the industry.
An example of an oligopoly is the credit rating agency industry in the US, which is dominated by three firms (Moody’s Investor Services, Standard and Poor’s, and Fitch Group).
Industry Type 4: Monopoly
A monopoly is characterized by a single firm serving the entire market, where consumers have no other choice than to purchase from this one firm. Because there is no competition, the products sold by a monopoly are not standardized or differentiated, but unique. Moreover, barriers to entry are extremely high.
Since there effectively is no competition, monopolies don’t face price or any other type of competition. A firm in a monopoly position has significant market power, allowing it to set prices as desired. Because of the possibility of abusing this strong degree of market power, monopolies nowadays are either regulated by government regulatory agencies, or have been expropriated by governments and are operated as public firms. Examples of this are Hydro Quebec or Via Rail in Canada.
There are two types of monopolies: natural monopolies, and artificial monopolies.
A natural monopoly exists when it is not economically feasible to have more than one supplier providing a product or service, generally due to significant fixed costs, as is the case in large fixed distribution networks (power lines, cable lines, pipelines).
An artificial monopoly is a monopoly imposed by law, not due to economic reasons. An example is the Ontario Lottery and Gaming Corporation (OLG).
Acknowledgements
Much of this article is based on Dr. Kenneth N. Matziorinis’ book “Business Economics: Theory and Practice”, 8th Edition, 2022, Canbek Publications (ISBN: 978-1-7751038-3-7).