Structure Conduct Performance

Paradigm
ECN4181 Industrial Economics
Lecture 2

chris.meilak@um.edu.mt
 Contents
Background
Structure
Conduct
Performance
SCP approach explained
Relationships between structure, conduct and performance
Neoclassical developments of SCP approach
Case study: Entry barriers
Testing the SCP: empirical evidence
Measuring variables
Defining markets and industries
Developments of SCP approach outside Neoclassical theory
Example: Food Security

2
 Background

3
 Background
Structure Conduct Performance (SCP) model postulates a
casual relationship between the structure (S) of a market, the
conduct of firms in that market (C) and their economic
performance (P). The SCP:
dates back to the work of E. Mason (1930s) and J Bain
(1950s)
is based exclusively on the neoclassical theory of the firm
(i.e. perfect competition, monopoly and monopolistic
competition, oligopoly)
has long been central to the study of industrial organization.

4
 Background
The SCP:
has been used to provide theoretical justification for competition
policy i.e. the SCP has provided the rationale for measures
intended to modify (or to prevent) the development of market
structures likely to promote behaviour and performance which is
considered detrimental to the public interest.
E.g. used by the US government in drafting antitrust policy
gained popularity among corporate strategists when Michael
Porter (Competitive Strategy, 1980) used it as an analytic tool for
businesses striving to compete within a market

But SCP approach has been criticised on a number of counts,

including on the fact that it is based too exclusively upon
neoclassical theory.

5
 Components of SCP

What do we understand by Structure?

What do we understand by Conduct?
What do we understand by Performance?
How do you measure Performance?

6
 What is Structure?
STRUCTURE describes the characteristics and composition
of markets and industries in an economy.
A. At its most aggregated level, it relates to the relative
importance of broadly defined sectors of the economy.
Industrial structure may be seen in terms of a three-sector
economy in which economic activity is classified as: PRIMARY,
SECONDARY, TERTIARY

B. Structure can also refer to the number and size distribution

of firms in the economy as a whole. E.g. largest firms by
revenue / market capitalisation

7
 Structure under the SCP
Under the SCP, STRUCTURE relates to the importance and
characteristics of individual markets within the economy.
Here structure describes the environment within which
firms in a particular market operate.

8
 Structure - characteristics
Principal structural characteristics:

Market Concentration: number and size distribution of buyers

and sellers
Extent of product differentiation/ substitution
Ease of entry into the market/ barriers to entry/ exit
conditions
Extent of firm integration (vertical/ horizontal) or
diversification

Reminds us of Porters 5 forces model

9
 Porters 5 Forces
POTENTIAL
ENTRANTS

COMPETITION
SUPPLIERS BUYERS
AND RIVALRY

SUBSTITUTES

10
 Conduct
Conduct refers to the behaviour (actions) of the firms in a market,
to the decisions firms make and to the way in which decisions are
taken. E.g.
how firms set prices (whether independently or in collusion with
others in the market)
how firms decide on their advertising
how firms decide on research budgets, and how much expenditure is
devoted to these activities
plant investment, legal tactics, product choice, collusion, merger and
contracts.

These factors are often more difficult to identify empirically than

either structural or performance characteristics.

11
 Performance
The economists concern is with the performance of firms.
The essential question is whether or not firms operations
enhance economic welfare, i.e. how well firms satisfy
consumer requirement in the current time period.

Are they being productivity efficient?

Are they being allocatively efficient?

To answer these questions, we look at aspects of performance

such as the relationship between prices and costs, and the
level of profits earned.

12
 Performance

Productive efficient - avoiding wasteful use of available

factors of production

Allocative efficient - producing the right goods and in the

right quantities

13
 Performance
Under conditions of perfect information, economic welfare is
maximised when the Pareto marginal conditions are fulfilled,
i.e. where firms set Price = Marginal Cost.
In the neoclassical model of perfect competition, firms
maximise profits when price = Marginal Cost, and this
results in a price and output combination that is both
productive and allocatively efficient.

14
 Performance
Inferior performance is expected in markets that match the
neoclassical models of monopoly, oligopoly or monopolistic
competition. Although firms may be productively efficient,
the level of output is unlikely to meet the requirements of
allocative efficiency.
This arises as firms in such markets possess a degree of
market (or monopoly) power, i.e. they have some discretion
in determining the price at which to sell their output.
Unlike the model of perfect competition, they are able to
raise price above the level of marginal cost.

15
 Performance Lerner index
The Lerner Index (1934) or price-cost margin, presents a
theoretical measure of market power. See Lerner, A. P. (1934),
"The Concept of Monopoly and the Measurement of Monopoly
Power

MARKET POWER - discretion in determining the price of

output to be sold. Price Marginal Cost and is in fact Price >
Marginal Cost

Measured by Lerner Index = (Price Marginal Cost) / Price

LI = 0 -> perfectly competitive firm
I close to 1 -> greater market power

16
 Performance
Therefore essential concern of the SCP approach has been
with effects on current economic welfare.

However note that pricing/ profits are indications of

current/ past performance, hence yielding few insights into
how well firms will perform in satisfying customer wants
over time.

17
 SCP approach explained
Performance is determined by the conduct of firms, which in
turn is determined by the structural characteristics of the
market

Structure Conduct Performance

The linkage between structure, conduct and performance

then turns on matching the structural characteristics against
the models of perfect competition, monopoly, monopolistic
competition, and oligopoly.

18
 SCP approach explained
Example: We may use the SCP approach to contrast the
structures of two different markets.
Structural characteristics Market 1 Market 2
Number of firms Many, each with small Four (4), similar market
market share shares

Number of buyers Many Few

Nature of product Homogenous Differentiated
Entry barriers Low Substantial
Conclusion?

19
 SCP approach explained
Example: We may use the SCP approach to contrast the
structures of two different markets.
Structural characteristics Market 1 Market 2
Number of firms Many, each with small Four (4), similar market
market share shares

Number of buyers Many Few

Nature of product Homogenous Differentiated
Entry barriers Low Substantial
Conclusion? Perfect competition Oligopoly

20
 SCP approach explained market 1
Market 1 = Perfect Competition characteristics. Using SCP we can
make deductions about conduct:
Large number of competitors leaves firms with no choice but to
act independently in determining price and output levels.
Individual firms will be unable to influence the price determined
by the market
They have no reason to depart from this market-determined price
Price will tend towards MC
In the long run, firm will earn normal profits
Production is therefore productive and allocative efficient, to the
greater benefit of current economic welfare

21
 SCP approach explained market 1
Use of SCP for Market 1:
Straight-forward chain of reasoning
Gives clear guidance to policy-makers - Performance can be
improved by actions designed to influence the structure of
the market.
In this case (market 1 but also under monopoly), there is no
need to analyse the conduct performance can be predicted
directly from a consideration of market structure structural
conditions yield sufficient information to deduce how firms
MUST behave.

22
 SCP approach explained market 2
Market 2 = Oligopoly. Deductions about conduct:
Small number of equal-sized firms suggests that price, advertising
and other aspects of firm behaviour are likely to be decided
collusively.
Thus this leads to higher price and lower output compared with
Market 1.
But the structure of the market does not guarantee collusive
behaviour as the oligopolists may compete for increased market
share with the result that price is kept close to the perfectly
competitive level, hence giving an acceptable level of economic
performance.
Hence, using SCP here, only limited conclusions can be drawn.
Analysis of conduct is an essential component of the SCP approach
in oligopolistic markets.

23
 SCP approach explained market 2
Use of SCP for Market 2:
But the structure of the market does not guarantee collusive
behaviour as the oligopolists may compete for increased
market share with the result that price is kept close to the
perfectly competitive level, hence giving an acceptable level
of economic performance.
Hence, using SCP here, only limited conclusions can be
drawn.
Analysis of conduct is an essential component of the SCP
approach in oligopolistic markets.

24
 SCP approach explained - summary
Structure Conduct Performance
Perfect competition Profit maximisation Allocatively efficient
No advertising

Monopolistic competition Profit maximisation Allocatively inefficient

No advertising

Oligopoly Possible profit Allocatively inefficient

maximisation
Advertising and other
non-price competition
Monopoly Possible profit Allocatively inefficient
maximisation
Some advertising
25
 Critiques of the SCP approach
The following criticisms have been levelled at the SCP approach:
SCP draws on microeconomic theory from which to examine the empirical
behaviour of firms. However, economic theory does not always give us exact
relationships between structure, conduct and performance. E.g. oligopoly
theory can be seen as largely indeterminate, not generating any clear
deductions.
Structure can be measured by a multitude of indicators but there is
overemphasis on concentration.
SCP is concerned with static short run equilibrium (a snapshot). What about
the evolution of structural variables? How do conduct and performance
influence future changes?
Which variables belong to structure, which to conduct and which to
performance? E.g. advertising, vertical integration, diversification
Difficulties in measuring many of the variables (e.g. profitability, entry
barriers, rate of entry?)
What do we mean by performance? Profits? Variability in profits?

26
 Relationships between structure,
conduct and performance
The traditional premise that market structure is exogenously
determined is unsound. Performance and more particularly
conduct affect structure.
E.g. mergers directly affect the number and size distribution of firms
in the market;
E.g. innovation and advertising may raise entry barriers;
E.g. predatory pricing could force competitors out of the markets.
If market structure gives rise to conduct which raises prices and
enhances profits, then this may attract entry, modifying the
structure of the market.
Also, various structural elements are unlikely to be independent,
so that, for example, market concentration is likely to bear some
relationship to the height of the entry barriers.

27
 Relationships between structure,
conduct and performance
Hence the SCP may be adapted to incorporate more complex
linkages, although the essential causality still flows from
structural criteria.

Structure Conduct Performance

28
 Neoclassical developments of SCP
approach
One of the criticisms of the SCP is that it is too loosely
derived from its theoretical underpinnings, and this has led to
attempts to link the SCP more rigorously back to neoclassical
theory.

29
 Neoclassical developments of SCP
approach contestable markets
In Contestable Markets: An Uprising in the Theory of Industry Structure,
Baumol (1982) presented his notion of CONTESTABLE
MARKETS, which implies that a particular market structure does
not necessarily equate with a particular type of performance.
Markets are contestable where the costs facing new entrants are
similar to those of firms already in the market and where a firm
leaving the market is able to salvage its capital costs (minus
depreciation), i.e. there are no sunk costs.
Under this view there are no entry or exit barriers, so monopoly
profits cannot exist. The mere threat of entry forces existing firms
to minimise their production and distribution costs and, thereby,
to influence the structure of the market. Hence contestability
automatically ensures that good performance results
regardless of the structure that emerges.

30
 Neoclassical developments of SCP
approach contestable markets
In practise few markets are perfectly contestable, however there are
degrees of contestability. With lower barriers to entry and exit, the
market will be more contestable. Contestable markets are likely to have
competitive prices and low profitability.

Example Walking Tours

It is quite easy to enter this market:
Buy yourself a nice sign and wait on the main street for tourists to pay you.
As long as you can speak for an hour on the subject matter you can enter the
market. If you find the market is no longer profitable, you can leave with no
set up costs.
Therefore in theory, there is scope for hit and run competition.
The authorities could create barriers to entry by introducing the necessity to
get a permit to offer walking tours. For example, in Venice the number of
licensed gondolas is strictly limited meaning they can charge high prices
without threat of competition.

31
 Neoclassical developments of SCP
approach contestable markets
Example Airline industry
Assume there are just two airlines flying a particular route. If entry and
exit were costly, the market would not be contestable and the two
incumbent airlines might realize substantial economic profits from their
protected market position.

But in fact additional airlines can enter and leave this particular segment
of the air transportation market with minimal cost. The reason is that the
relevant capital equipment - the airplanes themselves -- are highly
mobile. Hence, if an additional airline were to enter and find this route
to be unprofitable, it could simply "pull out" by flying its equipment to
some other route. The awareness of the possibility of costless entry will
compel the two airlines currently flying this route to provide their
transportation services efficiently and at prices which yield only a
normal profit.

32
 Neoclassical developments of SCP
approach contestable markets
Example Software industry
It has been argued that the software market is a contestable one: entry
and exit are virtually costless.

What are the costs (if any) of entry into the word processor market?
What about the costs of developing a new web browser?
In other industries this was deemed to be the case - see Gillette case below
"In U.S. v. The Gillette Company and Parker Pen Holdings, the
government argued that entry was unlikely due to the brand name
barriers as well as the time required to design and manufacture a pen.
The government's expert argued further that product repositioning was
unlikely, sunk costs were large, and consumer loyalty reduced the
disciplining effects of entry. In contrast, Carl Shapiro, the parties expert
argued that entry barriers were low. The judge agreed that entry barriers
were low.

33
 Neoclassical developments of SCP
approach contestable markets
Example Airline and software industries
Mergers within industries such as banking, telecommunications, and airlines
have created a stir among consumers who argue that economic freedom and
efficiency are being sacrificed in favour of corporate profits.
The theory of contestable markets postulates that firms in imperfectly
competitive markets may act as though they operate in a purely competitive
market when entry and exit are perfectly (or nearly) costless.
Firms generate a normal profit when faced with the threat of additional market
entrants
As a result, consumers can continue to enjoy the lower prices that accompany
competition.
The merger between firms and subsequent strengthening of business
concentration may not have detrimental effects on consumers. The United
States Department of Justice has used this theory on antitrust cases to rule in
favour of the defendant.

34
 Neoclassical developments of SCP
approach efficiency
In Industry Structure, Market Rivalry and Public Policy, Demsetz
(1973) (Chicago School) came to a similar conclusion in
suggesting that high profits may be a sign of efficiency not
market power! Since in any market, the firm with the lowest
costs will tend to increase in size and market share over time,
there will be a tendency for market concentration to increase
but, at the same time, there will be pressure on all firms to
be efficient.
Consequently, Demsetz argues that market structure will
develop into that which enables production and distribution
to be undertaken at least cost.

35
 Neoclassical developments of SCP
approach focus on conduct
For proponents of the new industrial organisation (e.g. Price-
Cost Margins and market structure, Cowling and Waterson,
1976), SCP needs to be integrated more closely and
rigorously to neoclassical theory by moving away from the
emphasis on structure and focusing on CONDUCT. They
argue that CONDUCT is the key element not structure, and
conduct interacts both with structure (through choice of
output level) and with performance. However the structural
measure of market concentration is still given a central role.

36
 Neoclassical developments of SCP
approach revised (dynamic) model
In the 1980s, McKinsey Consulting suggested an extension
that added a dynamic element to a static framework. The
dynamic version suggests that the relationships among
structure, conduct, and performance are not unidirectional;
they flow in the opposite direction, too. This approach allows
companies to consider the influence of their own conduct on
an industry's structure and, ultimately, on their own
performance. Many companies use the revised model to
"play through" various scenarios that might affect them, to
gain an understanding of what's happening in their industries,
and to develop their strategies.

37
 Neoclassical developments of SCP
approach case study: entry barriers
Even if we accept that structure determines performance in
some predictive way, SCPs validity is undermined unless we
agree over which structural characteristics are important or
how the presence of particular characteristics is to be
interpreted.
Let us consider ENTRY BARRIERS, which enable established
firms to earn abnormal profits over the long run.

38
 Neoclassical developments of SCP
approach case study: entry barriers
ENTRY BARRIERS (based on work by Bain, 1956, in Barriers to
New Competition) defined as anything which places potential
entrants at a competitive disadvantage with established firms, so
that established firms are able to earn abnormal profits over the
long run. Bain identified three main types of barriers:
absolute cost (e.g. patents, access to superior resources, lower-cost
finance)
economies of scale (even if cost functions are similar, since new
entrant may operate at a scale which is too small to realise fully
potential cost advantage)
product differentiations (existing products have built up customer
goodwill; new entrants therefore have to spend more on promotion)

39
 Neoclassical developments of SCP
approach case study: entry barriers
Stigler (Chicago School) argues that entry barriers are
incurred by new entrants but not by firms already in the
industry. For example, product differentiation is unlikely to
act as a barrier since firms already in the market must have
previously incurred the costs of establishing goodwill.
First-mover advantages cause entry barriers, and occur when
the innovating firm retains a competitive advantage from
being first in the field. E.g. ownership of patents, reputation
effects (e.g. Thermos, Hoover, Coca Cola, Cutix nail polish,
Kenwood, Biro, Tipex, Jablo); the first firm to enter a market
may face low promotion costs because it has no rivals.

40
 Neoclassical developments of SCP
approach case study: entry barriers
Established firms may themselves undertake measures to raise
entry barriers here CONDUCT impinges on STRUCTURE
by reducing the entrants potential to earn abnormal profits
E.g. by lowering price to the LIMIT PRICE (which keeps out
entrants); the higher the entry barriers, the higher the limit price.
E.g. credible threats such as building excess capacity (Spence (1977)
in Entry, Capacity, Investment and Oligopolistic Pricing)
Bain assumed new entrant to typically be a new small firm
building its own facilities. But what if new entrant takes over
incumbent? What if new entrant is an established multi-product
firm (probably already in the same industry) which decides to add
an extra product to its range? What if new entrant is a foreign firm
which will serve the market by exporting from their home base?

41
 Testing the SCP
The SCP approach has generated a wide variety of empirical
work. Principal tests of SCP have sought to relate profits (or
price) to:
1. Market concentration
2. Market concentration plus entry barriers
3. Differences in relative or absolute firm size causing
differences in efficiency or in the rate of innovation
4. Differential growth rates which imply that markets are in
disequilibrium
5. The level of advertising relative to sales (advertising
intensity)

42
 Testing the SCP
Many of the tests using regression analysis show significant results. BUT there is a problem of
interpretation: a significant relationship says nothing about the direction of causation.
Example: a strong positive relationship between profits and advertising intensity may be
evidence of market power, the causation running from structure to performance. Equally it
could be a result of the fact that higher profits result in a larger advertising budget.
Bain (1951 ) 42 industries in 1936-40 divided into most/ less concentrated successful
collusion between firms (concentration ratio) results in joint profit maximisation measured as
return on equity (confirmed by Mann in similar study for 1950-1960)
Stigler oligopolists wish to collude in an effort to maximise profits sample of 17
industries based on 1953-57 data relationship between profit rates and four firm
concentration ratio in excess of 80%
Weiss (1971) 23 studies weak but positive relationship between profitability and
concentration.
Brozen in case of successful collusion in concentrated industries, above average profits
should persist over time market is in disequilibrium

43
 Testing the SCP
MacAvoy, McKie and Preston only industries with
persistently high concentration levels should be studied
Demsetz (1973) reasons other than collusion (e.g. economies of
scale, effectiveness, efficiency) CAN explain the positive
relationship between profitability and concentration.
Spandau correlation between profitability and concentration in
South African manufacturing industry based on profitability as
measured by gross output as a measure of wages, not sales
Samuels & Smyth (186 companies between 1954-63)/ Hart &
Barron (1951) negative relationship between profit rates and
firm size
Koch (1974) - a strong relationship between concentration and
price-cost margins may even disappear when other structural
variables are introduced.

44
 Testing the SCP
Smirlock et al. (1984) positive relationship between profits and market
share, between profits and growth, but no relationship between profits
and concentration and between profits and entry barriers.
Schmalensee (1985) US data on 546 firms in 261 industries industry
effects explain 75% of variations in profits, while firm-specific effects
are less important
See Lipczynski and Wilson (2001), pgs. 172-177, and Heather (2002),
pg 34, for other empirical tests
The validity of the empirical tests undertaken has been questioned.
Donsimoni et al. (1984) suggest that exercises seeking to relate profits
to several structural variables are certain to yield some correlation. But
tests that focus on particular aspects of market structure may yield
results that are not robust and are difficult to interpret.
Empirical studies of SCP should use cross-sectional data only if the
structure of the market is stable. In practice, market stability is unlikely!

45
 Measuring variables
Testing SCP faces practical problems
E.g. in studies of profitability, profit by itself is an incomplete
measure. Some firms have greater variability of earnings
(measured by in the CAPM model: r = rf + [rm rf]) and
hence require higher returns to compensate.
Thus if an empirical study does not account for this CAPM
relationship, then if earnings variability is positively related
to concentration, any positive relationship between profits
and concentration may reflect this influence (i.e. earnings
variability) rather than market power.

46
 Measuring variables
The choice of profit measure is itself a fundamental issue. Empirical studies have
used:
a) Accounting returns on asset (accounting Rate of Return on Assets,
Accounting Rate of Return on Equity) -
Theoretically a firms entry to (or exit from) a market is in response to
differences in returns on assets so this should be the profit measure of
choice. However, the treatment of depreciation might mean that accounting
measures might bear little resemblance to the true economic return.
Another deficiency occurs where a firms main source of competitive
advantage comes from intangible assets (e.g. reputation, brands, customer
relationships). Accounting standards prevent the real value of these assets
being incorporated into company accounts (unless there is an acquisition),
which can bias profitability estimates in cross-section studies and overstate
the stability of profits over time.
Lack of standardisation in accounting conventions which complicates direct
comparisons.

47
 Measuring variables
b) Price-Cost Margin, i.e. (Sales Purchases Salaries) / Sales
excludes capital costs and advertising expenses, thus inflating
margins in those industries where capital and advertising
intensities are high
c) Tobins q (ratio of firm stock market value to replacement value
of firm assets)
Rationale is that the greater a firms ability to earn profits on a
given set of assets, the more attractive it will be to equity
holders this will raise the firms market value but estimating
the firms replacement value is not that straight-forward

48
 Measuring variables
How do you measure entry barriers? (Measures using sunk
costs have been unsuccessful; CEO survey based on Likert
scale, very subjective)
How do you measure entry to market? (new firms? Market
penetration/ share of new entrants? Net entry? Net market
penetration? )

49
 Markets and industries
Apart from the fact that firms produce a variety of different products,
and may hence belong to more than one industry, the line of
demarcation between the products belonging to one industry and those
belonging to another cannot be drawn in an absolute sense.
When testing the SCP approach, remember to distinguish between
markets and industries:
MARKETS group together firms whose products are close substitutes from
the buyers point of view (product demand side). Cross-elasticity of demand
between products within the market is HIGH. (e.g. family cars, sport cars).
Not always easy to identify clear boundaries. There is also the geographical
dimension which needs to be taken account of.
INDUSTRIES: product groups which are close substitutes from the
suppliers viewpoint (product supply side). An industry is usually a broader
grouping than a market. (e.g. transport vehicles) and can be seen as
comprising firms which have the ability to produce, relatively rapidly, the
products of any of the other firms in the group.

50
 Markets and industries
For purposes of analysing price and output levels of a
particular product, the market is the more relevant concept.
When considering new entry into a market, this is more
likely to come from firms which are in the same industry.
Rather than the whole market, it may be more meaningful to
undertake analysis at the level of the firm, or groups of firms
with similar characteristics (e.g. strategies), i.e. a strategic
group, e.g. local banks which offer personal services, local
banks which focus on merchants only

51
 Developments of SCP approach
outside Neoclassical theory
Neoclassical models are STATIC they show the equilibrium
properties of markets, but fail to show the paths by which new
equilibria are reached.
In reality, information is not perfect; tastes are not constant, there
is uncertainty, technology cannot be taken as given =>
competition is a dynamic process.
Clark (1940), Towards a concept of workable competition,
argues that perfect competition model has its limitations and
therefore it is dangerous to use it as a yardstick to judge markets
(for policy). He argued that economic welfare would generally be
enhanced by markets whose structure actually departs from the
perfectly competitive point.

52
 Developments of SCP approach
outside Neoclassical theory
Andrews (1964) in On Competition in Economic Theory,
regarded competition as a process, using term open competition
to describe an industry open to the entry of new competition.
Austrian School/ approach:
Reject assumption that economic agents possess perfect
knowledge of all aspects relevant to their decisions.
Knowledge is only partial. (e.g. aware of your tastes but not of
available consumption possibilities)
Reject the neoclassical concern with the state of equilibrium and its
mathematical properties. i.e. according to the Austrians, even though
the economy may be expected to move in the direction of
equilibrium, the characteristics of the equilibrium are constantly
changing, and the state of equilibrium is never attained. Economy is
constantly in flux.

53
 Developments of SCP approach
outside Neoclassical theory
Reject the neoclassical view of competition. Major issue for Austrian
school is the competitive process, the ways in which economies
evolve through time and how decisions are made in conditions of
uncertainty and limited information. The actions of
entrepreneurs, spurred by the pursuit of self-interest, drive
the competitive process.
For the Austrian school, the essence of the competitive process is
entrepreneurial action working through the market mechanism to
transfer resources to superior uses. In the neoclassical world of
perfect knowledge there would be no need for entrepreneurial
activity (there are no unsatisfied demand or unexploited
opportunities), and no competitive process.
However, statistical testing of Austrian approach is difficult.

54
 Conclusive discussion
SCP approach involves the logical application of neoclassical
models to draw deductions about the performance of markets
Therefore the SCP is derived from a well-established body of
positive economics, and deals with the objective rather than the
subjective. Hence it is attractive and widely used.
However, SCP is open to criticism on several counts, including
excess reliance on neoclassical theory equilibrium states and
perfect information are never found in practice and are abstract
conditions, hence SCP could lead to misleading analysis.
But some markets MAY be sufficiently stable for the SCP approach
to generate useful results. E.g. The slower the pace of technology,
the more constant are peoples tastes, and the more mature the
market, the more likely it is that the SCP approach will NOT be
misleading.

55
 Conclusive discussion
Thus, for example, the SCP approach is more suitable for
analysing the car market at the end of the 20th century than at the
beginning.
It appears we know very little from the empirical studies of
relations between structure and profitability. E.g. market
concentration may be the cause of high profits or, conversely,
market concentration and high profits may be the result of
superior performance by a few firms. Better theory, better data
and above all, better econometric analysis are needed before
policy can be based on anything other than in-depth institutional
studies of particular markets.
An important way forward would be to develop a synthesis that
recognises the unique feature of the individual firm, and links this
to aspects of the market.

56
 SCP Example Food security
Source: http://pdf.usaid.gov/pdf_docs/PNADL965.pdf (US Agency for
International Development Famine Early Warning System)
Market structure consists of the relatively stable features of the market that
influence the rivalry among the buyers and sellers operating in a market. Some
examples of market structure include the number of buyers and sellers of food
commodities in the market, the number of sellers of agricultural inputs such as
fertilizer and veterinary drugs, barriers to entry into the market and the nature
of trading relations among market participants.
Market conduct refers to the patterns of behaviour that traders and other
market participants adopt to affect or adjust to the markets in which they sell or
buy. These include price setting behaviour, and buying and selling practices.
Market performance refers to the extent to which markets result in
outcomes that are deemed good or preferred by society. Market performance
refers to how well the market fulfills certain social and private objectives. These
include price levels and price stability in the long and short term, profit levels,
costs, efficiency and quantities and quality of food commodities sold.

57
 SCP Example Food security (S)
STRUCTURE Number of buyers - With few buyers and sellers, they may
engage in non competitive behaviours such as collusion and price
discrimination.
A few buyers of pastoralists livestock - Traders offer farmers low prices which reduces
incomes of rural agricultural households.
A few sellers of food commodities in the market - Retailers gain market power and
increase food prices, which reduces the amount of food poor households can purchase
with a given amount of income, therefore, making them relatively more food insecure
than if prices were lower.
A few sellers of agricultural inputs such as fertilizer and veterinary drugs -Traders
overcharge farmers for agricultural inputs such as fertilizer which reduces their use of
inputs and ultimately their yields and income. In the case of veterinary drugs, livestock
farmers fail to buy vaccines, which could lead to animal diseases and deaths, reduced
prices for livestock, lower incomes and increased food insecurity among pastoralists.
A few transporters of agricultural products working between production areas and
markets - Transporters charge higher prices for transporting people and food
commodities which reduces farmer profits, thus reducing household income.

58
 SCP Example Food security (S)
STRUCTURE Barriers to entry - This refers to factors that restrict the
participation of households or traders in the market
Farmers and traders lack access to credit - Farmers and traders fail to market or store
commodities to sell when prices are high, thus reducing returns. When farmers store
and sell later in the season, seasonal price swings become less dramatic, leading to
increased income and food security of both producers and consumers.
Smallscale traders and households are deterred from starting businesses or trading,
which reduces their opportunities to earn income - Traders and farmers pay high license
fees before starting to trade. High license fees deter farmers from delivering output to
markets by themselves, which leads to higher prices and low household income. Traders
attempt to push the costs onto farmers in the form of lower producer prices and onto
consumers in the form of higher consumer prices
Traders pay high export and import taxes -With export taxes, the countries goods
become more expensive to potential importers, and producers in the exporting country
obtain less income from the sale of their surplus output. With Import taxes, traders and
consumers in the importing country face higher food prices, sometimes food shortages.
Traders control critical locations and assets such as stores and markets - A few traders
limit the participation of other traders in the market, and make households to pay high
food and input prices.

59
 SCP Example Food security (S)
STRUCTURE Vertical integration/ coordination - Farmers and livestock
herders get less income depending on whether traders buy produce
directly from farmers, middlemen, or transporters.
Farmers sell their products in terminal, spot or auction markets - Farmers obtain
efficient or competitive prices because many buyers and sellers converge in terminal,
spot or auction markets. However, spot market prices tend to be volatile, therefore
subjecting households to price and income risks when prices fluctuate due to changes in
supply and demand for food commodities. In addition, farmers can deliver commodities
to spot markets but fail to sell when there are few buyers.
Farmers sell directly to buyers at their homes and/or farms - Farmers get less income,
but do not incur costs of transporting produce to markets.
Farmers sell through contracts to traders - Farmers obtain predictable prices and
income, thus reducing food insecurity. Sometimes farmers get lower prices compared to
those obtained when farmers sell on the spot market. Unlike selling on spot markets,
however, if farmers deliver in contract arrangements, the quantities are specified in
advance, implying that farmers have assured markets under contract sales.
Farmers engage in group marketing, or are organized as cooperatives - Farmers obtain
higher prices and income due to increased bargaining power, and trading in high
volumes.

60
 SCP Example Food security (C)
CONDUCT Pricing Setting Behaviour - Who sets the price? How are prices determined?
Traders jointly determine the price to offer producers (e.g. a few buyers of cattle secretly negotiate and agree to
offer herders lower prices) - Prices offered to cattle herders are lower than those that would have prevailed in a
competitive environment with many buyers. This behaviour severely reduces incomes of rural livestock herding
households.
Traders jointly determine the price to charge consumers (e.g. a few sellers of veterinary drugs collude and charge
livestock farmers higher price) - This behaviour increases costs and reduces the use of vaccines and drugs, results
in less healthy animals and higher mortality rates, poor quality livestock upon sale and consequently reduced
incomes of rural pastoralists.
Traders collude and pay lower prices to maize farmers - Reduces incomes of rural agricultural households, causes
maize growers to cut costs by limiting employment of farm labourers and reducing the use of inputs, which
ultimately can reduce output.
Government sets consumer prices - If the price is set very low, consumers benefit through access to cheap food.
Government sets producer prices -When prices are set above prevailing market prices, and the process is handled
well, agricultural households get more income, which increases their access to other food needs. Poor agricultural
households that are net consumers could actually be worse off because they have to pay more for the food they
access through the market.
Traders demarcate trade areas/regions and offer different farmgate prices to farmers in these different
areas/regions for the same quality and quantity of agricultural commodities - Price discrimination makes traders
underpay some farmers which results in reduced incomes.
Traders charge different prices to different consumers especially if traders can differentiate between rich and poor
consumers - Overcharged consumers buy less food commodities and undercharged consumers buy more food
commodities for a fixed amount of money. Thus the overcharged lose and the undercharged benefit.

61
 SCP Example Food security (C)
CONDUCT Buying and selling practices
Consumer prices are not transparent or openly displayed - Traders charge different
prices to different consumers for the same commodity thus subjecting some households
to higher costs and less food purchases.
Producer prices are negotiated in private arrangements and secret bids - Traders offer
different prices to farmers when buying agricultural commodities. This difference in
prices leads to less income for poor households.
There are no grades and standards followed when selling and buying - Traders tend to
pay a lower price than the one that corresponds to the fair average quality, resulting into
less income for households. Farmers do not get price premiums for producing higher
grade food commodities.
There are no standard units of measurements in the market for volumes traded such as
weighing scales - Farmers are cheated when they go to sell in the market and thus get
less income from the sale of food commodities.
Farmers sell in small quantities and they do not engage in collective marketing - Farmers
do not gain higher prices and income due to lack of increased bargaining power and lack
of economies of scale and size from trading in high volumes.

62
 SCP Example Food security (C)
CONDUCT Other conduct
Consumers can return goods or services that are damaged or below
standard. (i.e. goods and services are guaranteed) - High quality goods
and services are more likely to be sold to farmers and consumers.
Traders merge to form one large business - Traders gain market power
and start overcharging consumers, thus reducing the amount of food
households can buy. However, it is also argued that when traders merge,
they face reduced costs and gain efficiency. Reduced costs and efficiency
gains results into lower consumer prices for food commodities.
Traders lobby politicians or city council officials to control markets or
collection of market dues - A few traders gain too much power when
they control markets. They can start to charge higher taxes from other
small traders and consumers, which reduces the amount of money spent
on food by other households.

63
 SCP Example Food security (P)
PERFORMANCE Price levels and stability
Long run - Consumer prices for staple food crops and livestock products are
higher than normal during the same period of time in previous years - Market
dependant households with fixed amount of money have reduced access to food
from the market.
Stable and affordable prices - Households that depend on the market for food,
become more food secure.
Over space - The difference between consumer prices in two nearby locations
differs by more than transport, marketing and transaction costs -This spatial
difference can indicate that areas with high prices are more food insecure
compared to those where prices of staple food crops are lower. Factors that
cause this include poor infrastructure, civil unrest and climatic conditions.
In the short run - Consumer prices of food crops and products change very
frequently over a short period of time in some areas - This subjects poor
households to uncertainty and possibly reoccurring price shocks because food
becomes very expensive to buy and planning or budgeting for basic food
expenditures becomes very difficult.

64
 SCP Example Food security (P)
PERFORMANCE Profits (net returns)
Traders receive excessive profits or net returns from sales of food commodities - This
implies that traders are overcharging food commodities, compared to costs they incur,
thus reducing the amount of food that poor households can access relative to fixed
incomes.
PERFORMANCE Margins and costs
There are large differences between prices paid by consumers and prices received by
farmers compared to marketing, processing and transaction costs for a given commodity
-This indicates that produce buyers or processors are underpaying households that
produce agricultural commodities and/or overcharging households that buy food
commodities for consumption. These two phenomena reduce incomes of agricultural
households and food access for households that depend on the market as a source of
food, exposing them to food insecurity.
PERFORMANCE Volumes (quantity)
There is a regular supply (volume) of staple food crops and livestock products entering
the market - No shortages of food crops in the markets. This is good for food availability.
Quantity of food entering the market falls below the usual average - Prices can increase,
reducing the amount of food that households can access.

65
 SCP Example Food security (P)
PERFORMANCE Product quality (including nutrition) and
variety
The quality of food in the market is poor or below acceptable standards,
which could have nutritional implications for households and particular
members of households - Households are not able to consume the right
amount of food with the required composition of nutrients for
productive health.
Food varieties are limited or different from the types that are preferred
or typically consumed in some parts of a country - Households that
dont access the food they prefer or a variety of nutritious foods become
food insecure.
PERFORMANCE Food Distribution within market
Regular supplies to different markets in the country - Access to food to
all areas including those with vulnerable populations increases food
security.

66