Chapter 7: The Nature of Industry
Firms need to make decisions regarding their pricing policies and thus they need to know the
optimal price. Nevertheless, it is the nature of the industry where the firm is operating that makes
the pricing strategy of different firms differ.
Market Structure – Factors that affect managerial decisions, including the number of firms
competing in a market, the relative size of the firms, technological and cost considerations,
demand conditions and the ease with which firms can enter or exit the industry
The following are the factors that affect pricing decision:
Firm size
Firm size affects how managers run the company and decide on the pricing strategy. Different
industries give rise to different size of firms
Industry concentration
This is about whether the industry has many small firms or few large firms.
Concentration ratios- Measures how much of the total output in an industry is produced by the
largest firms in the industry
The four-firm concentration ratio- The fraction of total industry sales (St) generated by the four
largest firms (S1 to S4) in the industry.
C4 = (S1 + S2 + S3+ S4)/ St or C4 = (W1 + W2 + W3+ W4) where Wn= Sn/St
The closer the C4 is to 1 the higher the concentration of the industry
Herfindahl-Hirschman index (HHI) – The sum of the squared market shares of firms in a given
industry multiplied by 10,000.
HHI = 10,000∑wi2
, The closer the HHI value to 10,000 means fewer firms exist in the industry
Limitation of concentration measures:
Global market – imports are often excluded from the analysis although it may constitute a large
proportion of the industry.
Different markets - many relevant markets for industries are very local. Thus, even though in the
national level the concentration may be low, that might not be the case in the regional or local
market.
Industry definitions and product classes - depending on the definition of the industry, the
concentration may differ. Hence, the more specific the market is the more concentrated the
industry is.
Technology
Technology is the one that makes industries differ from one another. Some industries need a lot
of capital investment while others are more labor intensive. In the more technological-intensive
industries, when one firm possesses a more efficient capital then the manager can really put the
cost down and charge a lower price.
Demand and Market Conditions
In the market where demand is relatively low, managers need to adjust the product price to
compete in the market.
In the market where there is an ease of information flow, the consumers can compare price easily
and thus managers need to actually take note of their competitors.
Elasticity of demand also varies across industries. In the market with many close substitutes, the
price will generally be lower than those markets that have few substitutes.
Rothschild index – A measure of the sensitivity to price of a product group as a whole relative to
the sensitivity of the quantity demanded of a single firm to a change in its price.
Rothschild index equation:
R = Et / Ef
Firms need to make decisions regarding their pricing policies and thus they need to know the
optimal price. Nevertheless, it is the nature of the industry where the firm is operating that makes
the pricing strategy of different firms differ.
Market Structure – Factors that affect managerial decisions, including the number of firms
competing in a market, the relative size of the firms, technological and cost considerations,
demand conditions and the ease with which firms can enter or exit the industry
The following are the factors that affect pricing decision:
Firm size
Firm size affects how managers run the company and decide on the pricing strategy. Different
industries give rise to different size of firms
Industry concentration
This is about whether the industry has many small firms or few large firms.
Concentration ratios- Measures how much of the total output in an industry is produced by the
largest firms in the industry
The four-firm concentration ratio- The fraction of total industry sales (St) generated by the four
largest firms (S1 to S4) in the industry.
C4 = (S1 + S2 + S3+ S4)/ St or C4 = (W1 + W2 + W3+ W4) where Wn= Sn/St
The closer the C4 is to 1 the higher the concentration of the industry
Herfindahl-Hirschman index (HHI) – The sum of the squared market shares of firms in a given
industry multiplied by 10,000.
HHI = 10,000∑wi2
, The closer the HHI value to 10,000 means fewer firms exist in the industry
Limitation of concentration measures:
Global market – imports are often excluded from the analysis although it may constitute a large
proportion of the industry.
Different markets - many relevant markets for industries are very local. Thus, even though in the
national level the concentration may be low, that might not be the case in the regional or local
market.
Industry definitions and product classes - depending on the definition of the industry, the
concentration may differ. Hence, the more specific the market is the more concentrated the
industry is.
Technology
Technology is the one that makes industries differ from one another. Some industries need a lot
of capital investment while others are more labor intensive. In the more technological-intensive
industries, when one firm possesses a more efficient capital then the manager can really put the
cost down and charge a lower price.
Demand and Market Conditions
In the market where demand is relatively low, managers need to adjust the product price to
compete in the market.
In the market where there is an ease of information flow, the consumers can compare price easily
and thus managers need to actually take note of their competitors.
Elasticity of demand also varies across industries. In the market with many close substitutes, the
price will generally be lower than those markets that have few substitutes.
Rothschild index – A measure of the sensitivity to price of a product group as a whole relative to
the sensitivity of the quantity demanded of a single firm to a change in its price.
Rothschild index equation:
R = Et / Ef
