Readers Question: Assess the impact on market contestability of increased use of the internet?
Definition of Market Contestability – Contestability means that a market has freedom of entry and exit. In other words, new firms can enter and leave easily; this creates a permanent threat of competition. Contestability requires low sunk costs (costs that are non-recoverable). If an industry has high sunk costs, it creates a cost to leave and deters entry.
How the internet has increased contestability
- The internet has provided a new entry point for many markets. For example, some new banks have been able to offer online banking services (such as Egg and Direct Line). This has made the market more contestable because new firms have been able to enter an industry with traditionally high barriers to entry.
- Reduced the fixed costs of entering a market. To set up a network of branches is a high fixed cost and therefore is a barrier to entry. The internet has enabled firms to compete with lower set up costs. Generally, the costs of running an online industry are lower than buying lots of high street retail shops. For example, a business can operate from home and sell goods via Amazon warehouses.
- More information. The internet has helped increase availability of information such as low prices. This gives new firms a better chance because the internet helps them to become established. Without the internet established firms often use their brand loyalty to keep prices high and deter new firms entering.
- The internet also enables firms to have better information about technology and cheapest suppliers reducing the advantage of established firms.
- The internet has often reduced sunk costs. To set up an online business requires less investment in bricks and mortar type spending. If an online business fails, the main sunk cost is the time of the entrepreneur.
- The internet works better for some industries than others. E.g. clothing retail doesn’t do well on the internet because people like to visit the shops. The market for air tickets, however, has become more competitive because the price is the most important factor
- The Internet creates its own barriers of entry. For example, it is difficult to get high google rankings unless you are established and have a lot of resources to promote your website.
- The internet has created new monopolies, such as Amazon. Amazon dominate the market for online retail. It is true many business use Amazon marketplace, but they are subject to the monopoly power of Amazon.
- Social media and similar networks create strong pressure on monopoly power. People tend to gravitate to the dominant business – not because they think they are best, but because they need compatibility with everyone else. (Network effects)
- People may not trust new online businesses. The internet has a reputation for ‘shady practices’
- Google has developed a very strong barrier to entry on the internet; it is difficult for anyone to compete with his huge resources and brand loyalty.