Industrial Economics ProjectQuestion 1Part (a)

The market share can be computed from a variety of variables – sales, assets and the number of employees the firms hire. For this market however, the sales figures are easiest to obtain and most appropriate for analysis.

For 2010, the sales figures are as follows in the tablet market.

Firm/Product Sales (units) Sales (US$)

Apple Inc. (iPad) 14,760,000 9,566,000,000

Samsung (Samsung Galaxy Tab) 2,000,000 1,220,000,000

Archos (2010 Archos Tablets) 137,328 28,000,134

HP (Slate 500) 20,000 16,000,000

Below is a pie diagram representation of the figures above based on the dollar sales.

Apple Samsung Archos HP

88.3%

11.3%

0.3%0%

Market Share for the tablet market (2010)

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Part (b)

Calculations for the Measures of Concentration in the Tablet Market for 2010

Firm Sales(US$)Market

Share (x) x2 x0.6 x3 1/x ln(1/x) x · ln(1/x)

Apple

Samsung

Archos

HP

Total

Measures of Concentration

CR3

HH Index

HK(0.6) Index

HK(3) Index

Relative Entropy

9,566,000,000 0.8833 0.7802 0.9282 0.6891 1.1321 0.1241 0.1096

1,220,000,000 0.1127 0.0127 0.2698 0.0014 8.8770 2.1835 0.2460

28,000,134 0.0026 0.0000 0.0280 0.0000 386.7839 5.9579 0.0154

16,000,000 0.0015 0.0000 0.0200 0.0000 676.8750 6.5175 0.0096

10,830,000,134 1.0000 0.7929 1.2461 0.6906 1073.6681 14.7829 0.3806

Numbers Equivalent

0.9985 N/A

0.7929 1.2612

1.2461 0.8025

0.6906 1.4481

0.0423 1.1023

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Part (c)

• CR3 = 99.85%

This ratio means that the top three firms in the tablet market for 2010 enjoy 99.85% of the market share. The remaining firms have 0.15% of the market share. This is clearly a very concentrated market.

The main weakness of this measure of concentration is that it doesnʼt take into account all firms in the market. In this case, it takes the three top firms and ignores the rest. We cannot get an idea of the distribution of the ignored firms. If there is change in the distribution outside the top N firms, the concentration index will not be affected. A change in the distribution of market share within the N chosen firms will not affect the concentration index, provided that none of the firms exit the market (Curry & George, 1983). We would get the same result if Apple, Samsung and Archos had 33.3% market share each – which would be very different market structure and not reflected in the measure. It goes without say that the whole measure is dependent on the choice of N, which can give drastically different results depending on the market. In our analysis, there is really no significant change in the index with whichever N we choose. Choosing N as 1, 2 or 3 will make a small difference in the interpretation due to Appleʼs very high market share.

• HH Index = 0.7929

This measure shows that the market is indeed concentrated. The HH for a monopoly is 1, and our result (0.79) is quite close to 1. A more useful way of interpreting this is the numbers equivalent calculated to be 1.3, which means that this tablet market roughly consists of 1 firm. It seems that Apple is very close to being a monopoly in this market.

The guidelines by the Justice Department of the U.S. declare that when the HHI is between 1000 and 1800, the market is acceptably concentrated and if it is over 1800 the market is concentrated. Our HHI is 7929 which is 6130 points above the acceptable concentration level set by the Justice department.

• HK(0.6) Index = 1.2461, HK(3) Index = 0.6906

The HK(0.6) index has attached more importance to the smaller sized firms. The higher the figure, the lower the concentration level. At 1.2461, it is quite concentrated. Its corresponding numbers equivalent is 0.8 - almost 1. Even with α as 0.6, the concentration level is still very high.

The HK(3) index now attaches more importance to the large firms. It has fallen to 0.6906, which means that the concentration level has increased with this measure. The numbers equivalent stands at 1.4 - increasing because of the higher chosen α.

Because the HK depends on the chosen α, it is important to know which α to choose. To maintain accuracy of results for interpretation, a range of values for α need to be used (Curry & George, 1983). In our case, due to Appleʼs large market share, the choice of α is not very significant as they all result in a high concentration level result.

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• Relative Entropy = 0.0423

Our RE is quite low, at 0.0423 whilst the RE for a monopoly is 0. The RE is an adjustment to the entropy measure which gauges the degree of uncertainty in the market. When the entropy measure is very low, it implies that the firms in the market are certain about the market conditions, guarantee of customers etc like in a monopoly. The numbers equivalent is 1.1023, which confirms our view that the market is monopolized.

General Criticisms.

‣ All the concentration measures calculated above are static rather than dynamic. They give us a picture of the market at only one instance in time. They cannot tell us the state of the market over time. In just a yearʼs time, the competition level has changed much in the market for tablets with new and strong competitors to both Apple and Samsung which have reduced their market shares considerably.

‣ The indices all depend on the definitions we use of the market and market share. In Curry & George (1983), this weakness has two levels. The first is in the calculation of the market share itself. There are a number of ways of calculating the market share – value-added, sales, employment, assets, etc. The sole use of sales as the basis for the market share creates a bias for the firms that sell only. In our case, Apple - the market leader does not do any production of the tablets, whilst the other companies manufacture and sell. To use the number of employees as the basis for market share will seriously understate the firms that are mostly capital intensive. The use of assets has issues when it comes to valuation and getting the most accurate figure is time consuming as it will depend on who values the assets and their honesty.

The second level is on the market definition itself. What firms to include in the analysis is very important in determining the index. To be accurate, our market has to include all the substitutes (Lipczynski & Wilson, 2001). A broad market definition will understate the true concentration index and a narrow market definition will overstate the true concentration index – therefore the challenge lies in accurately defining the market.

‣ The third weakness is multiple-product operations. Different products produced by the same firms also compete with each other. In our survey, some respondents stated that with a 5% increase in the price of a tablet they wanted to buy, they would switch to a smartphone from the same company. Separating the products in different markets and analyzing them would result in debatable results because a firm may lose sales from one of its products only to be compensated by a sale of another product of a much higher value. The measures of concentration cannot capture this anomaly.

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Demand-Survey SSNIP TestThis section will determine whether the market for tablets is the correct market to be analyzed. Since we cannot perform the SSNIP test due to lack of data, we will attempt to duplicate a similar situation. Our sample size is 50 prospective tablet users. The first question will attempt find out whether the producers of tablet computers will still be able to make a profit after the 5% price increase. If over 50% of the answers for this are ̒ yesʼ then we can conclude that the market is properly defined because the producers will be able to profitably raise their prices. If most of the answers are ʻnoʼ and the respondents come up with a range of alternatives, then we must broaden the market definition to include the substitutes.

Qualifications:The accuracy of this test rest lies on the following qualifications.

1. We assume that the customer preferences have not changed significantly between 2010 and 2011.

2. We assume that the sample taken is a representative of the global market for tablets.

Findings:Out of the 50 respondents, 76% admitted that they would still buy the tablet computer regardless of the 5% price increase. This result increases our confidence that the market is well defined.

Though the market is quite well defined, in any case our qualifications donʼt hold and we are required to broaden the market definition we would include:

• Smart-phones (iPhone, Blackberry, Sony Ericsson, Samsung Galaxy etc)• Similarly priced laptops (Dell, Acer, HP etc)• Game consoles (PlayStation 3, Xbox etc)• Music Devices and headphones (iPod Touch, Beats by Dre)• Miscellaneous Items (Designer clothes, shoes and jewelry)

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Question 2$ “Determinants of sellersʼ concentration” are factors which dictate number of sellers in a market. As of 2010 the concentration in the tablet computer industry was high but it is decreasing with time due to new entrants. Determinants of sellersʼ concentration can be either systematic or obey random growth hypothesis. The following determinants are applicable in the tablet computers industry; economies of scale, innovation, network effects, legal and industry growth. Due to volatility of technological gadgets industry random growth hypothesis will also be acknowledged.

$ Big Tablet computer sellers such as Apple and Samsung enjoy economies of scale and scope. iPad and Samsung Galaxy tab bills of materials are $229.35 and $205 respectively (iSuppli 2010). These are very low costs of production considering the superior quality the two devices offer. Cost reducing agents by these sellers are a result of bulky orders, economies of learning and using similar production resources for different products. High efficiency reduces costs and increase reliability; this can lead to an increase in market share and hence higher concentration. To keep up, an entrant has to offer high quality tablets at low cost but this requires heavy investment in high-tech inputs; such costs deter entry. Michaels argues that entry cost is low, hardware is cheap to produce and open source software is readily available (TechieBuzz 2011). In his argument he did not consider other aspects such as labor and marketing costs. He also ignored industry competitiveness and long term sustainability of the startup company.

$ Moreover, diverse product portfolio gives large tablet computer sellers advertising economies of scale. In case of a De novo entry, the entrant might need to spend heavily on advertising. According to Geronski, heavy advertising by the incumbent can be a barrier to entry, “there seems to be little doubt that heavy advertising by incumbent makes entry more difficult for many new firms” (1995). If entry is by diversification advertising costs may not pose a barrier. $$ Samsung spent $ 6 billion on research and development in the year 2009(Dunne-CS Monitor 2010). Even-though spending much on research and development does not guarantee superior technology in most cases companies which invested heavily on product development are more innovative and have better distinctive capabilities. An entrant might need to spend heavily in research and development to keep up with the innovative pace of Samsung and Apple. Obtaining research and development funds can be challenging especially for a DE novo entry. $ Factors such as switching costs and network effect can still pose a challenge for diversified entry. All established tablet PC sellers have online stores which offer a variety of applications. These applications transform a tablet from an electronic device to a lifestyle platform to the user. Most of the applications are not created by tablet manufactures but rather 3rd parties. The applications creators focus more on tablets with more market share hence a new entrant has a disadvantage in the variety of applications it will offer in comparison to the incumbents. This increases incumbentsʼ distinctive capabilities as well as market share and hence higher concentration. An entrant can opt to use available open source software to override network effects but it will not be able to differentiate itself and gain market share.

$ Patents are also a barrier to entry. If it were possible to copy Appleʼs and Samsungʼs technology, entry could be easier. Since the technology used by incumbents is

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patented an entrant will have to invent new technologies. This will require heavy investment in research and development or buying rights to use other companies technology; both cases will inflate startup costs.

$ Industry growth rate is inversely related to sellersʼ concentration (Wilson and Lipczynski 2001). The tablet computer industry is in its initial stage, as the market grows, concentration is expected to decline due to increased demand. This argument of entry is illustrated by the diagram below which shows the stage development of product market (Gort and Klepper (1982).

$ Gort and Klepper suggest that at initial stages (stage 1 and 2A) the rate at which companies enters the market will be high. The potential for market growth will attract new entrants though factors such as network effects and customer loyalty seem to deter entry.

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Below is a forecast of tablet computers sales to illustrate potential growth of the industry.

Tablet computer industry is in its initial stages. We are yet to prove that systematic determinants are the only ones to determine the market outcome. There is a room for random growth hypothesis to influence market outcome. Moreover, there are many niche markets which are yet to be covered by incumbents; it cannot be said for sure which factors will determine entry of unexplored markets.

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The Economist, 2011

Question 3As at 2010, the tablet computer industry had a three firm concentration ratio of 0.9985 signifying a monopolistic market structure with Apple being the dominant firm with market shares of over 75%. Although Apple made large amounts of profits on its iPad it can be justified that this did not occur as a result of abusive market power. Although the tablet computer industry has an extremely high concentration ratio, the profitability of Apple originates from their efficiency and radically innovative technologies. (Arthur 2011)

Demsetz (1973) states if large firms in a particular industry are more profitable than the smaller firms in the same industry, the large amount of profits made by the larger firm reflects their efficiency and not the effects of a high concentration. Although Apple was a clear monopolist in the industry it faced heavy competition from other rivals such as Samsung, Archos and HP. It is usual for a monopoly to make excessive profits by limiting its output by creating ʻartificial scarcityʼ or by colluding with the other firms in the industry. However Demsetz went on to say that there are other factors that lead to a firm enjoying supernormal profits that does not involve the abuse of its market power. The outstanding performance of a specific firm can be the result of a combination of great uncertainty and luck, or an atypical insight by the management of the specific firm. Another possible source of profits could be the result of superior and dedicated entrepreneurship which came when Steve Jobs returned to Apple as CEO.

It is usual for supernormal profits to be eroded over time due to imitation by competition. However in the case of Apple duplication of technology is difficult due to years of research and development and the experiences gained from it. Even if Appleʼs technologies were readily available difficulty in duplication has allowed Apple to earn a large amount of profits from its iPad reinforcing that Apple does not use its market power to earn supernormal profits. (Demsetz, 1973)

The revisionist view put forward by the Chicago School of Economics complements Demsetzʼs view that bigger firms are more efficient which results in the bigger firms making higher profits. The efficiency hypothesis reinforces the positive relationship between market share and profits of Apple. Research done by Ravenscraft (1983) found that price-cost margins are positively related to a firmʼs market share while Branch and Gale (1982) used PIMS data and came to the conclusion that market share is the main determinant of profitability. The empirical results found by Abdullah (2008) when analyzing the market for commercial banks confirms the efficiency paradigm put forward by Demsetz (1974) to suggest that some banks are more technically efficient than others and as a result earn higher profits proving that the root of Appleʼs profits come from efficiencies and not abuse of market power.

The SCP Paradigm states the market structure of a particular industry will play a role in determining the concentration. This will determine the conduct of the firms which in turn will determine profitability of the firms. The market for tablet computers has only four sellers with Appleʼs market share being the largest making it the only monopoly. As Appleʼs market share is larger it can invest heavily in branding, advertising, marketing and research and development creating barriers to entry. (Blakely 2008) Conduct such as this could be the cause of Apple profitability. However as explained before, Demsetzʼs theory proved that efficiency leads to profitability disproving the SCP Paradigm. Furthermore the Austrian school of Economics says abnormal profits do not arise due to abusing market power but because profits make entrepreneurs like Steve Jobs to make decisions to

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improve resource allocation in the long run. (Lipczynski & Wilson 2001) Although the SCP paradigm states that higher levels of concentration and higher barriers to entry are associated with higher profits Feenyʼs (2000) empirical investigation of the Australian Tax entities proved that such characteristics count only for a 6% variation in profits amongst different firms. This further validates that Appleʼs large amount of profits could not be a result of abusive market power as abusive market power stems from the level of concentration.

$ Therefore it is safe to conclude that the Appleʼs profitability was achieved as a result of Appleʼs efficiencies and not because of Apple abusing its market power.

Word Count: 2658

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APPENDICES

APPENDIX A: Data and Calculations for Tablet Computers

Calculation of Prices for Archos Tablets

Generation 7 Archos Tablets

Archos 5 Internet Tablet Released 2009: (199.99USD, 249.99USD, 449.99USD):

AVG Price = 299.99USD

Source: Archos (http://store.archos.com/archos-internet-tablet-p-90.html)

Archos 7 home tablet series Released 2010: (129.88 USD)

Source: CNET (http://reviews.cnet.com/tablets/archos-7-home-tablet/4505-3126_7-34093843.html?tag=mncol)

Archos 8 home tablet Released 2010: (179.99 USD)

Source: Tracy and Matt (http://www.tracyandmatt.co.uk/blogs/index.php/archos-8-home-tablet-review )

Average Price per Gen 7 tablet= (299.99+129.88+179.99)/3= 203 USD

Generation 8 Archos Tablets

Archos 28: 99 USD

Archos 32: 149 USD

Archos 43: 199 USD

Archos 70: 274 USD

Archos 101: 299 USD

Average Price per Gen 8 tablet = (99+149+199+274+299)/5 = 204 USD

Source: Engadget (http://www.engadget.com/2010/08/31/archos-unleashes-five-five-new-android-froyo-tablets-we-go-h/)

Sales Figures for Archos Tablet Computers

Total sales in 2010: 115 Million USD

Sales in first half of 2010 (1 & 2): 42 Million USD

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Source: Archos (http://www.archos.com/corporate/investors/financial_doc/Results_S1_2010_en.pdf)

3rd Quarter sales in 2010: 24 Million USD

Source: Archos (http://www.archos.com/corporate/investors/financial_doc/Revenue_Q3_2010_en.pdf)

4th Quarter sales in 2010: 49 Million USD

Source: Archos (http://www.archos.com/corporate/investors/financial_doc/PressRelease-Q42010-02222011_en.pdf)

Calculation of Number of Units Sold for Archos Tablet Computers

Before Gen 7 tablets were introduced per quarter sales: 42/2= 21 Million USD

Increase in sales due to Gen 7 tablets= 24 Million – 21 Million= 3 Million USD

Therefore Number of Gen 7 tablets sold: 3,000,000/ 203 = 14,778 Units

Before Gen 8 tablets were introduced per quarter sales: 24 Million USD

Increase in sales due to Gen 8 tablets: 49 Million – 24 Million= 25 Million USD

Therefore Number of Gen 8 tablets sold: 25,000,000/204 = 122,550 Units (Rounded Off)

Total Number of Archos Tablets Sold = 14,778 + 122,550 = 137,328 Units

Number of Units Sold for Apple and Samsung

Data for the total Number of Apple and Samsung Tablets sold were obtained directly from the company websites.

Number of Units Sold for HP

The estimated demand for the HP Slate was 5,000 Units. However in the first month of sales (November 2010) the actual demand was 9,000 Units.

9,000/5,000= 1.8

This means that almost twice the amount of HP tablets was demanded in one month. So in the following month (December 2010) the demand could have easily doubled bringing the total of HP tablets to 18,000 Units. Considering that fact that December is the Christmas season the total number of sales for the HP Slate was rounded off to 20,000 Units.

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APPENDIX B: Questionnaire for the SSNIP Test

Questions:You plan to go buy a tablet computer next week. The price you are willing to pay now is $500. There is a sudden announcement of a 5% increase in price. The new price is now $525.

1. Would you still go buy the tablet computer? 2. If your answer in 1 is no, what would you buy instead?

Respondent Buys tablet after 5% price increase

Doesnʼt buy tablet after 5% price increase

Provides the alternatives

A1 1 0 0

A2 1 0 0

A3 1 0 0

A4 0 1 Blackberry Phone

A5 0 1 Clothes, Shoes, Jewelry

A6 0 1 Sony Ericsson Xperia

A7 1 0 0

A8 1 0 0

A9 0 1 Shoes, Clothes

A10 1 0 0

A11 1 0 0

A12 1 0 0

A13 1 0 0

A14 1 0 0

A15 1 0 0

A16 1 0 0

A17 0 1 PS3

A18 0 1 Phone+ Headphones

A19 1 0 0

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Respondent Buys tablet after 5% price increase

Doesnʼt buy tablet after 5% price increase

Provides the alternatives

A20 1 0 0

A21 1 0 0

A22 1 0 0

A23 1 0 0

A24 1 0 0

A25 1 0 0

A26 0 1 Similar Priced Laptop (10”)

A27 1 0 0

A28 1 0 0

A29 0 1 iTouch + Beats Headset

A30 1 0 0

A31 1 0 0

A32 1 0 0

A33 1 0 0

A34 1 0 0

A35 1 0 0

A36 1 0 0

A37 0 1 A cheaper tablet PC

A38 1 0 0

A39 0 1 Similar Priced Laptop (10”)

A40 1 0 0

A41 1 0 0

A42 1 0 0

A43 0 1 Samsung Galaxy SII

A44 1 0 0

A45 1 0 0

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Respondent Buys tablet after 5% price increase

Doesnʼt buy tablet after 5% price increase

Provides the alternatives

A46 1 0 0

A47 1 0 0

A48 1 0 0

A49 0 1 Gold Earrings

A50 1 0 0

Total 38 12 See Findings

A ̒1ʼ on the second column means the respondent answered ʻyesʼ to the question. A ̒0ʼ on the second column means the respondent answered ʻnoʼ to the question. The same applies to the third column.

All the respondents answered willingly and no record of names or any personal identifying information was taken. There was no prize offered for answering the questions. We also made clear to the respondents that the data was collected to complete an assignment question.

Interestingly, some respondents noted that they would still buy the tablet computer to a maximum of a 15% increase in price (up to $575). That is 10 points higher than is required for the test.

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iSuppli (2010) “Samsung Galaxy Tab Carries $205 Bill of Materials, iSuppli Teardown Reveals” Available at http://www.isuppli.com/Teardowns/News/Pages/Samsung-Galaxy-Tab-Carries-$205-Bill-of-Materials-iSuppli-Teardown-Reveals.aspx , accessed on the 13th of November 2011

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