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Market Power

A measure of the ability of a company to successfully influence the pricing of its products or services in the overall market

What is Market Power?

Market power is a measure of the ability of a company to successfully influence the pricing of its products or services in the overall market.

 

Market Power

 

Factors influencing Market Power

 

1. Number of companies in a market

For a company to hold extensive market power in the industry in which it operates, the industry must not be heavily concentrated. Market power is inversely related to the number of companies present in the market. Fewer companies mean greater market power is available to each player.

 

2. Elasticity of demand

For a company to exert market power, it must be faced with an inelastic demand from its customers. It would mean that regardless of the price of the product, there is a persistent need for the product. Companies can achieve an inelastic demand curve by providing unique products and services that create value for the customer.

 

3. Product differentiation

If a company can provide differentiated products and services that are able to fill a hole in the market, it will gain market power. Industries where substitute products are readily available, companies don’t hold market power.

 

4. Ability of companies to make above “normal profit”

In a perfectly competitive market, where buyers and sellers are both price takers, it is not possible to make above-normal profits in the long run. If there is a scenario where companies can make profits above the normal profit range, more companies will join the industry seeking the same, and it will dilute the position of each player and bring down the profits to normal. A company with great market power will be able to make profits above “normal profit.”

 

5. Pricing power

If a company offers distinguished products and services or holds extensive market share, it can dictate the pricing of its products and meet the inelastic demand from customers. A high degree of pricing power helps a company achieve market power.

 

6. Perfect information

If an industry enjoys a perfect flow of information and there is no mismatch between facts and information available to sellers, players will not achieve market power.

 

7. Barriers to entry or exit

If an industry has high barriers to entry or exit, the players will typically not hold market power. High barriers to entry mean if an industry is enjoying above-normal profits, and they are protected as not many players can enter to disrupt the enabling circumstances.

 

8. Factor mobility

If an industry provides equal ease of access to inputs of its products or services, the market power of individual firms will not be better off.

 

Market Power in Different Market Concentrations

 

1. Perfect competition

In a perfectly competitive market, multiple sellers sell a standardized product to multiple buyers. There are many sellers in a homogeneous market that enjoy fluid factor availability. Barriers to entry or exit do not exist, and companies cannot make above “normal profits” in the long run.

Buyers in a perfectly competitive market will enjoy perfect information regarding the product or service. Since all products in the market are substitutes of one another, the demand for products is extremely elastic. All companies are price takers and hold zero market power.

 

2. Monopolistic competition

Monopolistic competition is a kind of imperfect competition wherein a smaller number of sellers slightly differentiate their products by branding or customization in function. Because of such trait, the products in the market are not perfect substitutes for each other, and sellers can demand variable prices.

In the long run, however, the demand is elastic as companies can eventually modify their products to suit the market’s needs. Barriers to entry or exit do exist, but they are low. Perfect information is not available to the buyers and sellers; there is ambiguity to be exploited by a more knowledgeable player. Sellers in a monopolistic market are price setters and hold low market power.

 

3. Monopoly

In a monopoly, a single company is the sole seller of a distinct type of product or service. The products are not merely customized by a different specialized category in their sphere. Due to the unique nature of the product, the demand remains inelastic, and the company can exercise extensive pricing power and make profits that are above “normal profits.”

The industry is characterized by extremely high barriers to entry and exit, as the existing company may be protected by patents, and the factor mobility does not exist. Buyers are unable to access perfect information and, in some cases, the sole seller can exploit the market by indulging in price discrimination. A monopolist frim enjoys extremely high, if not absolute, market power.

 

Additional Resources

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Aggregate Supply and Demand
  • High-Low Pricing
  • Oligopoly
  • Total Addressable Market (TAM)

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