Essay: Analyse industrial organisation of the mobile phone industry, disprove validity of the structure-conduct-performance (SCP) paradigm

1.1 Focus: The focus of this report is to analyse the industrial organisation of the mobile phone industry, while aiming to support the disprove the validity of the structure-conduct-performance (SCP) paradigm. The SCP model identifies three different components/features: structure, conduct and performance, together they help to analyse the relationship between the structure of the industry itself, the way firms conduct themselves within the industry (e.g. pricing and R&D) and performance of the industry as a whole. The SCP paradigm was revolutionary for its empirical focus on cross sectional industry data, compared to previous theoretical analysis (Lypcynski et al, 2005). The report will assess in detail the composition of the mobile phone industry, analysing the key central questions in modern industrial organisation. The SCP paradigm states that industry performance is dependent upon exogenous structural patterns of demand and supply, combined with the behavioural conduct of incumbent firms (Caves, 2006).
1. The Mobile Phone Industry Today
The mobile phone industry is one the largest markets in the world. Although the likes of Apple’s and Samsung’s technological devices have fully penetrated Europe, North America and China, the mobile phone industry is ever expanding into emerging economies across Asia, Africa and South America. And with the consumer behaviour of ‘bigger’ and ‘better’ new smartphones are a necessity for some dedicated customers. According to a new study from ‘HIS Markit’, the global smartphone base will increase from 4 billion devices in 2016 to over 6 billion smartphone devices in use, by 2020 (Telecomtv.com, 2017). Globally smartphones and tablets already account for more than 60% of smart connected consumer devices, which is up from 16% in 2008 (Telecomtv.com, 2017). Due to the current economic environment of prosperity and growth the mobile phone industry is only set to increase in size. Ian Fogg director at HIS Technology said, “Revenues for smartphones shipped in 2020 will total £355 billion” (Telecomtv.com,2017). Currently the leading mobile phone producers in the UK and US are Apple and Samsung. The two dominant firms share a total of 81% of the market share in the UK (Statista.com, 2018).
2. Structure, Conduct and Performance (SCP) Paradigm
3.1 Background of the SCP paradigm: The structure, conduct and performance (SCP) paradigm was put forward by American economist Joe Staten Bain, 1912-1991. Joe Bain was a prolific and seminal writer and is considered as “the father of modern industrial organisation theory” (Policonomics, 2018). Since the conception of the SCP paradigm it has been considered as the key starting point when analysing key market features within industries.
Figure 1 below shows the model of the SCP paradigm. The central idea of the SCP model hypothesises a relationship between the structure (S) of a market, the conduct of firms in that market (C) and their economic performance (P). The model shows how each part of the model is linked and in comparison to the mobile phone industry, how governance effects each stage of the model. For example, the UK government regulate the profits large tech companies such as Apple earn through taxation to overall protect the industry.
Figure 1 – SCP Paradigm (Janjic A, 2016)
3.2 Market Structure: The structure encompasses variables ranging from the size and number of firms within the industry, product characteristics and barriers to entry and exit. Globally, the mobile phone industry’s main competitors are Apple and Samsung due to the more economically developed countries preferring a higher quality smartphone. On the other hand, the strong economic growth in China, Egypt and Nigeria has led consumers domestically purchasing smartphones from the relatively new market entrants of Huawei, OnePlus and Novo. In the UK however, is it clear the industry has a strong oligopolistic market structure.
As highlighted in Figure 1 above, there are many conditions which help to define market structure, e.g. market concentration, product differentiation and barriers to entry. In terms of the mobile phone industry in the UK the SCP model can be translated by comparing the elements such as the differentiation of Apple’s new face recognition on the Iphone XS and OnePlus’s new built-in screen finger print scanner (the first of its kind) on the 6T. Furthermore, one of the key components regarding market structure is market share/concentration. Figure 2 below shows the market share of mobile phones currently being used in the UK (2018). From the data it is clear that Apple and Samsung have a significant dominance within the UK mobile phone industry, collectively having 81% share of the market. Therefore, the structure of the UK mobile phone industry is heavily dominated by only a couple of firms, thus the paradigm can be used to described the UK mobile phone’s oligopolistic nature. Although this suggests the UK mobile phone industry may be inefficient and lacks regulation, ultimately consumer preference is the reason for this. Smartphone users in the UK are drawn to the big names of Apple and Samsung as they have provided prolonged quality albeit at a high price. Suggesting a strong inelasticity composition of the market.
Concentration ratios such as the Hirschman-Herfindahl Index (HHI) are a clear way of assessing the concentration of an industry. Using the data collated in Figure 2 the HHI index is as follows.
Using the US measure of market concentration, 1000 and below is considered un-concentrated and 1800 and above is considered concentrated. Therefore, the HHI index value for the UK mobile phone industry portrays that it is a highly concentrated market which is solely dominated by two firms, Apple and Samsung.
Figure 2 – Market share of smartphone manufacturers in the UK, 2018 (Data collected from Statista).
3.3 Market Conduct: The second component of the SCP model is how firms conduct themselves, and this refers to the dimensions that firms compete on and also the degree of rivalry within the industry. In terms of the mobile phone industry, pricing strategies and advertising are significant factors linked to the success of companies such as Apple and Samsung. In 2015 Apple spent £1.8 billion on advertising alone (Business Insider, 2016). This shows that advertising is a huge part of the industry and Apple significantly rely upon advertising to create its strong brand image. Pricing in the mobile phone industry seems to be increasing phone by phone. Apple’s new Iphone XS Plus costs a total of £1,249.00, with Samsung’s new Galaxy Note 9 costing a total of £1,099.00.
Pricing affects both structure and conduct; one firms’ pricing and output decisions will affect the profit and market share of other firms. According to Paul Sweezy’s kinked demand curve (Figure 3), demand is elastic above the equilibrium price level thus, in theory leading to significant losses in market share due a rise in the price. When price is below equilibrium demand is inelastic which therefore leads to insignificant gains in market share from a deduction in price.
Figure 3 – Paul Sweezy’s Kinked Demand Curve.
In theory from over-viewing Sweezy’s model, increasing the price above equilibrium (each time a new phone is released) should result in a reduction of market share. However, in the case of the mobile phone industry the inelastic product composition of Apple’s and Samsung’s phone suggests that consumers will pay a higher price each time, highlighting the brand loyalty both firms within the market have created through conducting themselves efficiently in the industry.
3.4 Performance: Finally, performance looks at how the industry is doing as a whole. Regarding the ability to achieving profits, growth, efficiency technological progress, and overall quality. The focus is therefore based more on the industry’s growth rather than the firms. The key concern with economists when analysing the performance of an industry falls upon allocative efficiency. Allocative efficiency occurs when there is an optimal distribution of goods and services, taking into account consumer preference. As performance highlights the whole industry, Figure 4 below shows the actual/predicted smartphone shipments and growth rates from 2009-2019 (Nasdaq, 2016). The figure shows that shipments worldwide for smartphones is set rise until the end of 2018 then stagnate. However, it is predicted that smartphone usage will still increase significantly in developing economies. In 2014 there were 460 million smartphone users in China, by 2019, it is forecasted that this number will rise to nearly 690 million (Statista.com, 2018). The slowdown in growth in China, accompanied by a widening disparity of income will be a major factor as to why the growth rate is decreasing. Due to the technological development that occurs through R&D in the industry the type of smartphones on the market will evolve each year. This dynamic efficiency accompanied with product differentiation will significantly aid the mobile phone industry to keep improving its performance.
Figure 4 – Smartphones: Worldwide Shipments & Growth Rates (Based On Statista Data)
3.5 To what extent does the SCP paradigm support the Mobile Phone Industry: Ultimately the SCP paradigm has provided a consistent explanation of the structure, conduct and performance of the mobile industry, specifically in the UK. This report has demonstrated the key characteristics of the industry. Highlighting the high barriers to entry, highly competitive nature due to the HHI index, high spending on advertising and lastly the high profits and growth enjoyed by the industry’s largest competitors. When reviewing the alternative schools of thought, it suggests that some neo-classical economists would agree that these characteristics comply with an oligopolistic market. However, a criticism of this view is that a neoclassical economist’s view can be seen to be static and fails to consider the future development of the industry, unlike the Austrian school. Therefore, to an extent this report demonstrates that the SCP paradigm does provide a valid explanation of the mobile phone industry. However; SCP’s lack of focus on innovation and relevance to abnormal profits weaken its argument to support the mobile phone industry.
3. Industry/Market Composition
The following section of this report will examine the ways in which new and existing firms attempt to enter the industry and expand. It will also look at the specific barriers to entry they face and how they overcome them.
4.1 Barriers to Entry and Mobility: As mentioned previously the barriers to entry in the mobile phone industry are significantly high. In the UK it’s not only economies of scale, reputation and the overwhelming market share that Apple and Samsung already hold, but the key to being dominant in the UK’s market is brand loyalty.
Prior to 2016 it would have almost been impossible for the two Chinese companies OnePlus and Huawei to penetrate the UK market. However, designing a new smartphone that through innovation; has features that the XS and Note 9 didn’t have, was the best way to break down the entry barriers. Due to the reputation of Samsung and Apple, the price of their new phone exceeding £1,000 wasn’t going to be an issue for loyal customers. Therefore, to penetrate the market Huawei and OnePlus created the Huawei P20 Mate Pro and the OnePlus 6T for a lower price to under-cut the market. Moreover, to overcome the barriers of high quality that existed, they developed smartphones which had better battery life than the new XS and Note9, higher resolutions camera and better HDR display.
A key reason as to why this was successful was simply the price. Huawei and OnePlus knew the price would have to be significantly lower than the XS or Note 9 to attract any attention from consumers. Huawei and OnePlus being Chinese companies therefore had a comparative advantage over Apple and Samsung as they were also able to benefit from the economies of scale of production from within their own country. Huawei priced the P20 Mate Pro at £799 and the OnePlus 6T costs an even lower at £550 (techradar.com, 2018). This form of predatory pricing set by Huawei and OnePlus could cause other fringe market entrants to be frozen out in the near future.
This recent example has shown that the barriers to entry in the UK mobile phone industry can be broken down as Huawei and OnePlus have entered the UK market with a high quality phone, that is a fraction of the price of the XS. The success has come from their business model of aiming for a significantly lower marginal rate of return unlike Apple, not solely focusing on profit which has ultimately helped Huawei and OnePlus gain market share.
At the start of 2018 Huawei over took Apple to become the second largest phone manufacturer in the World. Huawei raced into the second spot selling 54.2 million phones in the second quarter. Increasing their market share to 15%, 3% higher than that of Apple in the global standings, (The Guardian, 2018). It is evident that Huawei have broken down the barriers to entry globally in the mobile phone industry. Ryan Reith, vice president of IDC’s Worldwide Mobile Device Tracker said, “The continued growth of Huawei is impressive, to say the least, as is its ability to move into markets where, until recently, the brand was largely unknown,” (The Guardian, 2018).
4. Conclusion
5.1 Which approaches provide the most valid insight into how markets develop over time?
The SCP paradigm provides a valid insight for market analysis. The SCP model has been developed using neo-classical economic theories of the firm, albeit at a static level. The structure for the market is a competitive oligopoly, demonstrating characteristics of interdependence with fairly homogenous products, tendency for non-price competition and a few dominant firms not colluding (Lypcynski et al, 2005). Therefore, the SCP paradigm does provide some valid insight into the mobile phone industry as oligopolistic competition does occur in the UK market alongside fairly homogenous goods. However; the SCP model fails to provide a dynamic approach when analysing markets over time.
With regard to the mobile phone industry the Austrian view (Joseph Schumpeter) provides a much more valid school of thought because this explains how it develops over time, for example there is evidence of abnormal profits from Apple/Samsung and these are beneficial to competition as it attracts investors and thus further innovation to reallocate resources in the market more efficiently.
Furthermore, the Austrian view holds a key emphasis on entrepreneurs, this a huge factor within the mobile phone industry as for these technological based firms such as Apple to develop over time the role of entrepreneurs is imperative for success. Steve Jobs (former C.E.O. of Apple) was instrumental in Apple’s success today. The Austrian critique states that firms within industry are rewarded for insight and capability due to role entrepreneurs played. In comparison the SCP paradigm rejects the view of entrepreneurs because it fails to consider more dynamic causes for development.
In conclusion, the Austrian school of thought is more valid in terms of how markets develop over time due to its dynamic nature. Furthermore, this theory allows for the continually changing nature of the industry and thus accounts for the high levels of profitability, innovation, competition and entrepreneurship that the SCP struggles to explain in detail.