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Competition

Competition: Where sellers aim to increase sales and profits by attracting customers from rivals in the market.

The amount of competition differs from market to market. In some markets, thousands of firms compete for the same customers, e.g. farms selling milk or restaurants in a busy city. In others, there is little or no competition, e.g. a country with only one internet provider.

Competition and firms

Most firms would rather not face competition, because without rivals they could charge more and would be under less pressure. But competition forces them to give customers value for money.

Advantages to firms:

• Efficiency: firms are pushed to keep their costs as low as possible, which makes them leaner and better run.
• Quality: to keep their customers, firms must offer good products and good customer service.
• Innovation: firms that keep improving their products or come up with new ideas can gain an edge over their rivals. One way is product differentiation, making a product stand out from rivals’ products.

Disadvantages to firms:

• Price: firms cannot charge much more than their rivals, or they will lose business.
• Lower profits: prices tend to be low, and the total profit in the market is shared between many firms.
• Risk of closure: a firm whose revenue does not cover its costs may have to close.

Competition and consumers

Advantages to consumers:

• Price: firms cannot overcharge, because consumers can easily switch to a rival selling a close substitute.
• Choice: there are many suppliers, each trying to make its product different, and new firms keep entering the market with fresh ideas.
• Quality: consumers look for value for money, so a firm with poor products or poor service soon loses customers.

Disadvantages to consumers:

• Uncertainty: unprofitable firms eventually close, so consumers may lose a business they liked using.
• Innovation: firms make less profit, so they may not have enough to spend on developing new products.
• Quality: some firms may cut quality to keep their costs down.

Competition and the economy

Advantages to the economy:

• Efficiency: firms must keep costs down to survive, so the economy’s resources are put to better use and less is wasted.
• Innovation: firms develop new products, production methods, technologies and materials to beat their rivals, which raises people’s standard of living.

Disadvantages to the economy:

• Wasted resources: when firms close, workers lose their jobs and machinery, land and buildings are sold off. Some resources are immobile, so it can take a long time before they are used again.

Large and small firms

Most firms in most countries are small, and together they produce a large share of output and jobs. However, the few large firms often add more to a country’s output than all its small firms put together.

Small firms

Advantages of small firms:

• Flexibility: the owner usually makes the decisions, so a small firm can react to change quickly, e.g. a small baker can make a one-off birthday cake to order.
• Personal service: customers can deal with the owner directly, and some are willing to pay more for this.
• Better communication: with only a few staff, communication is quick and informal, so decisions come quickly and staff tend to feel more motivated.
• Innovation: small firms are under pressure to think of new ideas to keep their customers, and they may be more willing to take risks.
• Lower wage costs: fewer workers in small firms belong to trade unions, so owners can often keep pay close to the minimum wage.

Disadvantages of small firms:

• Higher costs: small firms produce too little to gain economies of scale, so their average costs are higher than their larger rivals’ costs.
• Lack of finance: lenders see small firms as risky, and some, such as sole traders, cannot sell shares.
• Difficulty attracting good staff: they often cannot pay the wages or fund the training that highly qualified workers expect.
• Vulnerability: they have few resources to fall back on when trading conditions get tough, and they may be taken over by bigger firms.

Large firms

Advantages of large firms:

• Economies of scale: large firms produce on a big scale, e.g. buying in bulk, so their average costs are below what smaller rivals pay per unit.
• Market domination: well-known large firms can dominate a market, which may let them charge higher prices and earn higher profits.
• Large-scale contracts: only large firms have the resources to win and carry out huge contracts, e.g. building a new motorway.

Disadvantages of large firms:

• Bureaucracy: decisions are slow because many people must be consulted, and too many resources go on administration.
• Coordination and control: thousands of staff and many sites are hard to manage, and extra supervision adds to costs.
• Poor motivation: in a huge organisation, one worker’s effort can feel unimportant and there is little personal contact, so staff may lose motivation.

Factors influencing the growth of firms

• Government regulation: governments want healthy competition, so they investigate mergers and takeovers and may block those that would reduce competition too much. This can stop a firm from growing.
• Access to finance: growth costs money, e.g. to open new stores, build factories or buy other firms. A firm that can raise money from banks or investors finds it easier to expand.
• Economies of scale: in industries where costs fall a lot as output rises, such as car making, air transport and power generation, firms have a strong reason to grow. In others, such as hairdressing, there are few economies of scale, so firms stay smaller.
• The desire to spread risk: by selling new products or selling in new markets, a firm can keep going if one venture fails, so it grows by diversifying.
• The desire to take over competitors: buying a rival is a quick way to grow and also reduces competition.

Reasons firms stay small

Niche market: market for a product or service, perhaps an expensive or unusual one, that does not have many buyers, but that may make good profits for companies that sell it.

Four reasons firms stay small:

• Size of market: a market may simply be too small for a large firm, e.g. only a few very wealthy people can afford luxury yachts.
• Nature of market (niche): firms that serve a niche tailor their goods or services to a small group of customers with very particular needs, which larger firms often ignore. In markets where set-up costs are low, such as hairdressing, many firms compete, so none grows very large.
• Lack of finance: some owners want to grow but cannot persuade lenders to provide the money, as the business is seen as too risky.
• Aims of the entrepreneur: some owners already earn enough profit to live on and would rather avoid the extra responsibility of more staff, more borrowing and more work, or they want time for other interests.