Market Structure Essay PDF

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An industrial-economic analysis of the smartphone industry around 2007 - the launch of the iPhone. The essay used the idea of vertical/horizontal differentiation to explain the success of the iPhone of the change of market structure afterwards....

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Introduction From an innovative manufacturer of personal computers and music players, to arguably the most influential company in the smartphone industry, Apple Inc. successfully completed the transformation by instantly shocking the market with the launch of iPhone in June 2007. This revolutionary smartphone of Apple not only allowed Apple to break into the matured smartphone industry which has strong existing competitors, but also captured a great amount of market share in less than three years. This essay aims to analyze the market structure of the smartphone industry and assess the most crucial factors that made the launch of iPhone such a great success.

Market Structure before the launch On the supply side, the smartphone industry before 2007 was considered a good match for the oligopoly model. There were a few major firms that produced more than 50% of the industry supply, namely Nokia (34.2%), Samsung (16.2%) and LG (9%). (Passport,2017) As each major firm had more significant market power and influence on each other, firms took into account the strategies of other firms when making decisions. Also, the higher market power of the major players allowed them to set prices instead of taking them, hence generating higher profit margins. Therefore, to protect the profit margin, existing firms would make effort to prevent new firms from entering hence maintaining the current oligopolistic structure. As a result, what Apple tried to break into was a long-standing industry in which major firms had already established market dominance, and their strong willingness of entry deterring made it extremely challenging for any new firm attempting to enter the market. For Apple to make a successful entry and capture enough market share, designing a revolutionary product to differentiate itself dramatically from other products is not an option but rather a necessary condition. On the demand side, the market conditions in 2007 for smartphone looked much more welcoming as the strongly growing overall demand for smartphones in the US provided plenty of potential customers for Apple. As research shows, only 37% of the respondents already owned a smartphone while 14.4% have a smartphone purchase plan in the next three months (Peckham, 2017). From the hindsight, Apple has certainly benefitted from the rising demand for smartphones as it kept capturing more and more market share each quarter. Furthermore, as indicated in the survey, 44% of the respondents who planned to purchase a Smartphone stated that they wanted to buy an iPhone (Peckham, 2017), meaning Apple nearly captured half of the market growth in the smartphone industry. It is fair to say that the welcoming attitude of the US consumers should be considered a major contributor to the success of iPhone.

What makes iPhone revolutionary and what does it mean in economics? Despite the use of advanced technology (multi-point touch screen, large display and iOS

ecosystem), which already made iPhone 'a revolutionary and magical product that is literally five years ahead of any other mobile phone' as introduced by Steve Jobs, the most crucial factor that made iPhone even more revolutionary is its success in integrating various functions into one portable electronic device, hence capturing demands from many consumer electronics markets. Those markets were previously separated by products with specialized functions, such as music player (MP3) for music, laptop for internet and mobile phone for long-distance communication. 'In 2002, Steve Jobs realized that rather than carrying multiple devices with specialized functions, people preferred one device with multiple functions' (Mohr, Sengupta & Slater, 2004). To create a well-rounded cutting-edge product, Apple spent more than 150 million dollars and 5 years on the initial developing process, which eventually transformed Steve’s extraordinary vision into reality. From the perspective of industrial economics, what Apple tried to do with iPhone is a classic case of Vertical product differentiation. As seen in the Hoteling model, entering a market with existing firms and products that satisfy similar needs is not necessarily profitable, since the competition can barely be moderated by horizontal differentiation. Not to mention the considerable market powers of the existing major players might easily drive Apple out of the business. Therefore, the only possible move for Apple to make was to differentiate itself vertically from other firms, meaning to create a revolutionary smartphone with industryleading quality, to provide the most preferred smartphone in the market, hence capturing as much demand as possible from consumers with high willingness to buy in a short period of time. In fact, I believe what Apple managed to achieve with iPhone was more magnificent than what a normal vertical differentiation is able to do. The integration of the most advanced technologies and previously separated functions was a huge success, and the level of product differentiation was so significant that it became nearly impossible for customers to find a substitute with similar functions and qualities in the smartphone industry. Therefore, at least in the short run, what Apple created was essentially a Monopoly market in which itself was the only supplier, and the monopolistic position of Apple has entitled itself certain level of market power. In the next section, I will discuss what Apple did with its short-term market power and also how Apple put the nature of an oligopolistic competition into consideration in the decision-making process.

Apple’s Pricing Strategy and why Market Structure matters Profit maximization is usually the best option for a Monopolistic firm, as the total control of price and quantity makes it extremely easy to manipulate the market. As discussed previously, Apple’s vertical differentiation strategy has successfully put itself in a monopolist’s position. Theoretically, as discussed in the Coase Conjecture, the optimal strategy for a monopolistic firm producing durable goods is selling with commitment (not changing the price), as the ability of changing prices is not necessary beneficial. In Apple’s case, it seems keeping prices at a higher level to exploit consumer surplus and maximize profit would be the best strategy, especially when the dramatically increasing demand for

iPhone made it even easier to do so. However, in reality, Apple did the exact opposite with a series of continuous price cuts from 399$ in 2007 to 199$ in 2008 and eventually to 99$ in 2009, and the rationale behind it is quite interesting – it has nothing to do with profit maximization but everything to do with the market structure. When Apple entered the market in 2007, it made sure iPhone was much more advanced and innovative than all other products in the market. But given the oligopolistic nature, it is also reasonable to assume that competitors will quickly react to this entry and match Apple’s level of vertical differentiation, which will inevitably take away Apple’s monopolistic power and transform the industry into an oligopolistic competition again. Instead of maximizing profit, Apple decided to maximize market share by boosting its sales and cultivating consumer loyalty. This pricing strategy used is called intertemporal price discrimination (Froeb et al., 2016), meaning setting high prices initially to sell to consumers with the high willingness to buy then reducing the prices gradually to attract consumers with low willingness to buy. From 399$ in 2007 to 199$ in 2008, iPhone’s sales tripled from 4.7 million before the price cut to 15 million (approximately 12.9% of the market), (Statista, 2017) which provided a solid foundation of customers for Apple to compete against its competitors in the future. And as predicted, Samsung, Google and others reacted to the launch of iPhone quickly by developing their own versions of iPhone substitutes, with the most notable examples being Galaxy and Android ecosystem. If Apple decided to maximize short-term profit instead of capturing market share by cutting prices, the survival of iPhone in the competition against its substitutes would be much more difficult.

Conclusion The introduction of iPhone to Smartphone industry has been considered one of the most successful cases in business. In the first section, I briefly described the market conditions before the entry of Apple: Oligopolistic on the supply side and rapid growth on the demand side. Then in the second section, I used the ideas of Vertical and Horizontal differentiation to interpret the major factors that made iPhone such a revolutionary product. In the last section, I started with the analysis of Apple’s pricing strategy to explain Apple’s strategic rationale, in order to explain how the oligopolistic nature of smartphone industry played an influential role in Apple’s decision-making. From the perspective of Industrial Economics, I consider the excellent use of Vertical Differentiation and Intertemporal Price Discrimination to be the most crucial reasons why Apple not only broke into the industry but also successfully captured so much market shares in such a short period of time. (Word Count:1431)

References Froeb, L., McCann, B., Shor, M. and Ward, M. (2016). Managerial economics. Boston, MA: Cengage Learning. Mohr, J., Sengupta, S. and Slater, S. (2004). Marketing of high-technology products and innovations. Passport. (2017). Company Shares in the US Smartphone Industry. [online] Available at: http://0www.portal.euromonitor.com.pugwash.lib.warwick.ac.uk/portal/statisticsevolution/index [Accessed 11 Dec. 2017]. Peckham, M. (2017). Survey: Over Half of Future Smartphone Buyers Pick Apple’s iPhone | TIME.com. [online] TIME.com. Available at: http://techland.time.com/2012/01/09/surveyover-half-of-future-smartphone-buyers-pick-apples-iphone/ [Accessed 11 Dec. 2017]. Statista. (2017). Apple iPhone sales 2007-2017 | Statista. [online] Available at: https://www.statista.com/statistics/263401/global-apple-iphone-sales-since-3rd-quarter2007/ [Accessed 11 Dec. 2017]....