Competition: Meaning, and Why It Matters

What’s it: Competition is when one party tries to win something or be more successful than the other party. Competition between companies means that each party tries to get a more significant share of the market, for example, market share and profits.

Perfect competition vs. imperfect competition

The perfectly competitive market refers to a hypothetical situation where each firm does not have the market power to influence prices. They only act as price takers and use the market price as their selling price.

Companies do not have market power for two reasons.

First, the market consists of many firms of relatively small and similar size. Thus, they cannot affect market supply.

Second, the product is homogeneous and perfectly substitutes. That keeps consumers from incurring switching costs. When one producer increases the price, consumers will turn to competitors.

Meanwhile, imperfect competition takes various forms. The three most common are monopolistic competition, oligopoly, and monopoly. The firm acts as a price maker because it can set a price higher than the perfectly competitive market equilibrium price. They can do this through control of market supply or differentiation.

Under monopolistic competition, the market is made up of many players. They are relatively small in size, similar to a perfectly competitive market. As a result, competition in the market is also intense.

The high pressure of competition also comes from low barriers to entry and exit. New players can easily enter to take profit from the market. The entry of new players increases market supply and pushes prices down, reducing profit.

The main difference between perfect competition and monopolistic competition is market power. Under monopolistic competition, firms have market power, namely through differentiation. Whereas, in a perfectly competitive market, they don’t have it.

Under oligopoly, the market consists of a few players and serves many buyers. Some companies may dominate the market.

Companies have relatively high market power, both through quantity and differentiation. To influence supply, for example, some companies may collude in secret. They can also do it explicitly (cartel) as in the Organization of the Petroleum Exporting Countries (OPEC).

Barriers to market entry are also high. That reduces the threat of new entrants to market profitability.

Under a monopoly, the market consists of only a single producer and serves many consumers. The firm’s output represents market supply and thus has absolute market power. Also, the threat of new players is low because of the high barriers to entry. Consumers also face high switching costs because the product has no substitutes.

Monopolists can abuse market power to maximize profits. That may be through cutting output, enforcing price discrimination, or lowering product quality.

Such practices are, of course, detrimental to consumers. For this reason, monopoly markets are usually under government supervision.

Why do companies compete

The main objective of a business is to generate profits. They produce goods and services and then sell them to the same consumers. If a company can acquire more customers and retain them over time, fewer customers are available to other players. If they acquire a few customers, sales will be low, as will profits.

Thus, the ultimate goal of the competition is to fight for profits. Then we can translate it into several other targets such as:

1. Market share
2. Number of subscribers
3. Sales volume

Why is competition important

The government tries to promote competition in the market, for example, through antitrust laws. That’s important for several reasons.

First, competition is beneficial for the public. When producers compete to provide goods or services, it will lower market prices and better quality. Companies try to sell at lower prices than competitors to attract customers.

On the other hand, some companies may rely more on differentiation as a basis for competition. They develop higher quality and unique products so they can sell them at a premium price.

Second, the products on the market have become more varied. The company develops a unique selling point, which acts as a differentiator between its products and competitors’ products. That explains why consumers prefer one product to another. As a result, the more companies pursue unique selling points, the more varied the market’s products will be.

Third, competition leads to more innovation. To create unique selling points, companies must spur innovation. Likewise, achieving a lower cost structure requires innovation. Advances in technology, production methods, the internet are all examples of the results of innovation and competition.

Fourth, resource allocation is more efficient. Companies maximize the use of the input. They try to produce more inputs from the same number of inputs, one of which is through innovative production techniques. Long story short, the competition allows us to use resources at their best to meet our needs and wants.

How companies compete

The market competition takes not only the form of price but also non-price elements such as:

1. Quality
2. Product reliability
3. Credit terms
4. Delivery accuracy
5. Warranty
6. After-sale service

To compete successfully, companies develop strategies to achieve competitive advantage. Porter divides the sources of competitive advantage into two categories:

1. Cost leadership
2. Differentiation

Some companies may apply this strategy in the primary market, where the market size is relatively large. While others prefer to apply it in a niche market to avoid competitive pressure from big players.

Cost leadership. Companies operate on a lower cost structure than the industry average. To maximize profits, the company sets the selling price at the industry average price level.

Or, the company charges it slightly below the average industry price to attract more consumers to buy. In this case, the company relies on low prices to generate high sales volume. Then, they can lower costs and increase profits through higher economies of scale.

Differentiation. Under this strategy, the company produces a unique product, so consumers are willing to pay a higher price. Products have a higher profit margin.

Typically, differentiation targets quality-conscious consumers. They are less sensitive to price changes.

Companies implement both strategies and translate them into their various business functions. For a production function, for example through:

1. Mass production
2. Mass customization
3. Lean production
4. Total Quality Management (TQM)
5. Just-in-time

For the marketing function, companies translate both strategies in their marketing mix: price, product, distribution, and promotion.