Running head: 1

David S. Spencer

Thomas Edison State College

Author Note

This is the Final Project for the February 2014 term of ECO-112-OL, Microeconomics.

The primary sources for the information in this project are the 2013 annual reports for the

respective firms analyzed in this project. Because of this sourcing, the reports are not cited in the

text but are available in the references section at the conclusion of the project.

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This project will examine two companies whose products are common in everyday

American life. These two companies are American Water and Under Armour. These two

companies are very different in most aspects discussed in this project, and serve as two good

examples of how private firms operate in different market conditions.

American Water Works Company, Inc.

American Water Works Company, Inc. is a provider or water with operations throughout

the United States. American Water Works Company, Inc. is commonly known as American

Water and is traded on the New York Stock Exchange under the symbol “AWK” – The remainder

of this paper will refer to the company as AWK.

Product

This section of the project examines the primary product of AWK. AWK’s primary

product is the public supply of water to municipalities across the United States. AWK has a

secondary business in a complementary product to public water in their wastewater operations

business. AWK’s water and wastewater products are primarily used by residential customers.

AWK’s 2013 customers breakdown to 91% residential, 7% commercial, 0.1% industrial, and 2%

public sector and other customers. These numbers consider the number of customers by class,

not the total consumption by customer class.

Demand Factors

Because of the ubiquity of AWK’s product in the markets in which it participates, there

are many factors that influence the demand for its primary product. These demand factors

include, seasonal changes, draught, derivative demand change as an industrial factor of

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production, and derivative demand change as a factor of production for electrical power

generation.

The demand for water adjusts on a seasonal basis. This is easy to comprehend in

everyday life as it is common for a residential water customer to use more water in the spring,

summer, and fall in exterior applications than in the cold of winter conducting such activities

such as lawn and garden watering, power washing, vehicle washing, and filling of pools. Lawn

and garden watering activity increases even more in the heat of the summer when evaporation is

high and plants require more water to survive during the course of a normal summer season.

Conditions of draught can both increase or decrease the demand for AWK water

depending on the severity of the draught and the reaction of government authorities to the

draught conditions. In the early stages of a draught or in draughts where the water supply is not

threatened, the demand for water can actually increase as consumers look to replace water that

they may otherwise acquire from surface water, ground water, or collected rainfall that is reduced

or non-existent during the draught. However, in cases where the draught is severe and threatens

the water supply, government authorities are likely to implement water usage restrictions that

reduce the overall demand for water which reduces the volume of water supplied by AWK in

order to ensure that the affected areas do not run critically short of water.

Water is an important factor of production in many industrial applications. Because of

this importance to industry, the demand for water from industrial firms is subject to the changes

in demand for the product that the industrial water customer produces. Because of this

relationship, AWK’s water is said to have derivative demand as a factor of production.

This derivative demand relationship is also true in cases where AWK supplies the water

used as a factor of production of electricity. Electrical producers require more water when they

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produce more electricity. AWK has a very limited customer base of electrical power producers.

This customer set is primarily limited to peak power generation and backup power generation

facilities.

Supply Factors

There are two primary factors of supply for AWK’s public water product. They are the

water itself, and the supplies used to treat and transport the water.

Water

For the water itself, there are two primary sources from which AWK extracts its supply.

The two sources are surface water sources, and ground water sources. In addition to the natural

process of the water cycle effecting the productivity of these sources, the level of contamination

and pollution is also important in determining the usability of the water sources and the expense

required to take the raw water through the treatment process so that it can be distributed to the

public.

surface water sources include rivers, streams, lakes, and man-made reservoirs. These

reservoirs are generally created by damming steam systems in natural bowls. Surface water

sources require significant treatment before they can be used as public water by AWK because of

chemical pollution, human and animal waste, and bacteria and viruses living in the bodies of

water.

ground water sources of water come for water contained below the surface of the Earth in

aquifers. Because of the natural filtering effect of sediments, the water contained in aquifers

generally requires much less treatment than surface water sources. However the extraction of

ground water sources requires expensive drilling and the continual pumping of water from

sources that can be hundreds of feet below ground level. When ground water sources become

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polluted, they can remain that way permanently, sometimes reducing productivity and other

times removing that site as a source of water. Ground water sources also have a natural rate of

recharge. When the extraction rate is greater than the recharge rate, then the supply can become

exhausted and unavailable for future exploitation.

Energy and Supplies

Energy is a very important factor of production for the production and distribution of

AWK’s primary product. The majority of AWK’s operations rely on pumps of one kind or

another. Stable and reliable prime power and standby power is essential to AWK’s ability to

move water from its source to endpoint customers through those pump systems. Energy is a

variable cost present in each unit of water produced and distributed to customers.

chemicals are an important factor of supply for AWK. This is especially true for the

production of water that AWK extracts from surface water sources that are contaminated as

described above. The chemicals used for the treatment of water are generally produced by petro-

chemical firms and their price varies depending on the price of oil and of energy in the region

where the chemical are produced. Besides the energy used in AWK’s operations, the cost and

availability of chemicals are the most variable aspect of AWK’s supply operations.

The pipes and other materials used to fabricate the infrastructure that moves the water

from the source to the customer sites is the largest fixed cost for AWK. In many cases AWK

purchases or leases this infrastructure from public utility commissions, while in other markets

AWK owns and builds the infrastructure itself. In both cases, AWK is many times responsible

for the maintenance and repair of water mains and other lines.

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Available Substitutes

There are no readily available substitutes for AWK’s primary products of public water.

There are some limited cases where there is a ready substitute, but most customers do not have

any other options because of the alternatives cost or because of local laws and regulations. The

first possible alternative to AWK’s public water service is the use of privately treated or purified

water that is transported via commercial or private logistics. This could be in the form of bottled

water or through bulk water deliveries. In either case, this method for supplying water is very

inefficient and expensive because of the costs of capital, labor, and fuel involved in the

transportation of potable water privately. Because of this difficulty and expense, these private

water supplies are not considered an available substitute in AWK’s market for public water. The

other available substitute for AWK’s public water is the use of private ground water wells.

Although the initial cost of drilling and installing a well can be very expensive, there is very low

maintenance costs and the marginal cost of each unit of water is very low. Despite this

affordability, private wells are not considered an available substitute to AWK’s public water

product because private wells are not available to most AWK customers because of local

regulation preventing the installation of private wells on many sites. Other customers are unable

to install private wells because their property cannot support a well because of location or access

and purity of the local ground water. Overall there is no substitute available to AWK’s water,

and because of the simplicity of the product and purity regulations, there are is no differentiation

between AWK’s water and any other supplier’s water product.

For most installations in AWK’s customer set there are no available alternatives for the

wastewater operations that compliment AWK’s public water distribution; however, in some

cases, some customers have the ability – or requirement – to use private septic systems instead of

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AWK’s public sanity sewer and wastewater treatment. Most of these customers are located in

rural or very lightly populated suburban areas. While septic systems are a substitute, they are

generally considered an inferior substitute because of the expense and difficulty of maintaining

septic systems and because of the local ground and groundwater pollution that improperly

installed or maintained septic systems can produce.

Available Complements

As mentioned throughout this section of the project about AWK’s products, their two

primary products are compliments to one another. Public water supply is complimented by

sanity sewers and wastewater treatment, while wastewater treatment is useless without a

community water system to carry the waste. In addition to these two compliments available

from AWK, there are other available complements produced and supplied by other firms in the

economy.

The generation of electrical power is a close complement to the public supply of water.

Not counting that water is an input factor to most methods of generating electrical power, an

increase in the consumption of water generally indicates an increase in economic activity or

population that will also require an increase in the consumption of electricity.

Demand Elasticity

AWK’s water has high elasticity in the short run because of the seasonal changes in the

water usage by residential customers. This high elasticity continues into the long term as the

price and availability of water do not just determine the demand curve for the customers in a

given market, they can be the determining factor in the population and industrial growth in the

market or community.

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Capital and Labor Intensity

AWK is very capital intensive but requires very little labor to operate.

AWK’s production of public water is very capital intensive because AWK must build and

maintain water extraction, treatment, and distribution facilities that are designed to last decades.

Many of the facilities currently in use are at, or nearing, their end of life. This means that AWK

or partner agencies and firms will need to invest significant capital to rebuild or refurbish public

water infrastructure. Rebuilding assets that last decades is very expensive and requires charging

rates that cover AWK’s operating cost and the cost of investment in the infrastructure.

Despite the high capital intensity, AWK is not labor intensive. AWK has only ~6600

employees while they serve a customer base of approximately three million households and

firms

Technology

Technology, and the investment in new technology, is not important in AWK’s core

business of producing the public supply of water. This is because AWK is operating in a highly

regulated market where in many cases AWK operates infrastructure that is owned by a public

body or government. In addition the process of supplying water through a municipal system has

remained constant for decades.

Despite this lack of need for new technology in the core business, technology may play a

greater part in the future of AWK’s operations as new technology for remote water quality

monitoring and the smart distribution of water through the distribution network is built into new

or refurbished water systems to reduce waste in the distribution system. AWK is already using

some new technology on a limited basis in some of its markets with smart meter that track the

volume of usage over time to determine when there is the greatest demand for water.

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Technology and technology investment may not be vitally important in the production of

AWK’s product, but in AWK’s annual report from 2013 expressed concern about water supply

availability in some of its markets. New technology, such as recycling waste water into potable

water, may be essential in the future for AWK and for draught-prone and arid communities in

which AWK serves.

Market Structure

AWK operates as a monopoly. In most of the markets this is a government permitted

monopoly providing services as a regulated utility. In the terms of the four market structures,

AWK operates as a monopoly because it is the only competitor in its market and there are no

available cost substitutes to its product.

Under Armour

Under Armour, Inc. is a producer, marketer, and distributor of branded athletic apparel

headquartered in the United States with operations in North America, South America, Europe,

and East Asia. Under Armour is publicly traded on the New York Stock Exchange under the

symbol “UA” - The remainder of this paper will refer to the company as UA.

Product

UA produces branded athletic apparel manufactured from moisture-wicking fabrications

in designs and styles engineered for a wide variety of climates and activities. UA produces

products for climates from hot to sub-freezing and for activities ranging from walking and golf to

running and high intensity team and individual sports.

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Demand Factors

UA makes a majority of its sales through wholesale channels – meaning that UA sells to

retailers that then distribute UA apparel products to their retail outlets. The performance of these

retail outlets affects the demand for UA products sold in those outlets.

UA product demand is affected by seasonality. UA products are in much higher demand

in the fall and winter as consumers demand UA apparel during the fall clothing shopping season

and then continue to demand UA apparel as gifts during Christmas.

UA product demand is affected by UA’s ability to develop new designs, products, and

materials. Demand for branded UA products declines over time as other producers produce

comparable products and particular designs and styles go out of fashion.

UA product demand is also affected by general consumer discretional spending. During

downturns in consumer spending, UA demand will decline as UA products are not considered

necessities to most consumers.

Supply Factors

The two primary supply factors for UA are the availability of specialty materials used in

UA products and the availability and performance of third-party firms UA contracts to

manufacture UA products.

UA products are manufactured from specialty fabrics and other technically advanced raw

materials that are developed by third parties. In the short run, these advanced and specialty

materials are only available from a limited number of suppliers. Approximately half of the

materials used by UA in 2013 came from just six firms. The price of these materials is further

subject to price fluctuations with the fluctuation of commodity prices in petroleum and cotton.

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The availability of these materials is also subject to shortages because of the limited market for

these specialty materials.

The supply of UA apparel products is also determined by the availability and

performance of its unaffiliated manufacturing firms UA uses to produce its products. In 2013,

UA produced approximately 65% of its products in unaffiliated manufacturing firms at 26 sites

in 19 different countries. UA attempts to distribute the manufacturing of single products to

different sites in order to avoid a product outage because of a problem at one of its partner

facilities.

By using third-party firms for the manufacturing of its products, UA avoids the additional

complexity in the factors of supply that large in-house manufacturing operations would present.

Available Substitutes

The athletic apparel market is a highly competitive market in which UA faces a great

variety of available close substitutes. While no other firm can produce a branded UA athletic

apparel product, hundreds of regional and global firms produce products that are close substitutes

to UA athletic apparel. These include other firms producing branded athletic apparel from

specialty materials such as Nike and adidas; other manufacturing firms specializing in outdoor

apparel that has similar characteristics and usage as UA athletic apparel; and private label

products offered by some of the retailers distributing UA products.

Available Complements

UA athletic apparel has a variety of available complement products available. UA

athletic apparel substitutes include athletic footwear, athletic accessories, fitness software, and

athletic electronics and electronic accessory sensors.

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These products are complements because increased demand for UA athletic apparel will

correspond to an increase in the demand for these products that are used in complement to UA

athletic apparel products in recreational, intermural, and professional individual and team athletic

activities.

Demand Elasticity

Demand for UA athletic apparel products is highly elastic in the short run and in the long

run. The short run for UA is seasonal. As stated above in the factors of demand, the demand for

UA athletic apparel varies season to season. From year to year, the intensity of each season can

have a substantial affect on the demand depending on that years weather severity.

In the long run, UA athletic apparel remains demand remains elastic as consumers can

easily reduce or eliminate their consumption of UA athletic apparel products in favor of one of

the other many available substitutes in the athletic apparel and outdoor apparel markets.

Capital and Labor Intensity

UA’s production is more labor-intensive than capital-intensive. UA began as a startup

with only capital raised from the founding teams families and friends. The production of UA’s

products is very labor-intensive like most apparel operations; however, UA does not conduct

manufacturing in-house. Instead UA uses partner firms to operate widely distributed

manufacturing operations across 19 countries.

If considering the eternal manufacture of UA’s products outside the firm’s production,

then UA’s athletic apparel operation becomes relatively much more capital intensive. This is

because of the seasonality of UA athletic apparel demand. That seasonality means that UA’s

revenue is inconsistent through the year. That inconsistency requires that UA hold cash in

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reserve throughout the year to prepare for the capital intensive run up to the fall season on high

consumer demand for UA athletic apparel products.

Technology

In UA’s highly competitive market of rapidly changing materials, fabrication methods,

and designs, technology is extremely important in producing a branded product that can remain

competitive with hundreds of competitors. Because of this importance, UA owns a limited

number of fabric and process patents to protect some of the technological advantages UA

products have over competition of branded and non-branded close substitute athletic apparel

products. Without a technological advantage over other products, UA’s brand would lose value

and UA would lose the price power over their branded athletic apparel products.

Market Structure

UA operates in a monopolistically competitive market for branded athletic apparel. UA

operates in a monopolistic and not perfect competitive market in part because there is

differentiation between each firms products as a function of the difference in the material and

process used in the fabrication of the products. In addition, UA is the only firm in the market hat

has the right to produce its branded apparel, giving it a monopoly over those products and that

brand. Because of this monopoly, UA has pricing power over its products to the degree that UA

branded products can compete in the athletic apparel market. UA exists in a competitive market

with hundreds of producers and thousands of retailers providing supply close substitutes.

Because of this duality of branded monopoly and high competition between close substitutes, UA

operates in a prototypical examine of a monopolistically competitive market.

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Prospectus and Conclusion

When putting the analysis of these two very different companies together, it shows how

private firms can operate to create economic wellbeing and value in vastly different market

conditions. Below, this project concludes with the long term prospectus for the primary product

of the two firms examined.

American Water

AWK’s public water is essential to the economy and society in general. Because AWK’s

product is a necessity for all economic activity, the prospects for AWK’s water are bright as long

as the population and economic activity in AWK’s markets continue to grow. Even if population

and economic growth are taken as a given, there is the possibility of difficulty for the growth of

AWK’s water distribution. As noted in AWK’s 2013 Annual Report, there is the possibility of

future difficulty and disruption to AWK’s ability to supply water to its monopoly markets

because of the effects of “drought, governmental restrictions, overuse of sources of water, the

protection of threatened species or habitats, or other factors that may limit the availability of

ground and surface water.” Despite these concerns, the long term prospects for public water are

very good as increased efficiency and technological advancements in production and distribution

will ultimately provide the supply needed to satisfy growing demand in an ever more productive

and populated society.

Under Armour

The prospects for UA’s products are much more complicated in the long term than those

of AWK’s product. This complexity is due in part to the highly competitive market in which UA

competes. Determining the prospects fro UA’s athletic apparel products is also complicated by

the importance of technology and branding in the long term success of UA products. If UA is

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able to continue to consistently create new branded products that are technologically superior to

UA products’ close substitutes, then UA products will have a high probability of continued

demand growth and penetration into new geographic markets into the future.

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References

American Water. (2013). 2013 Annual Report.

Under Armour. (2013). 2013 Annual Report.