Market Contestability and the Internet

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 Helped Increased Contestability

  • 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 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 is lower than buying lots of high street retail shops.
  • 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.
  • Internet also enables firms to have better information about technology and cheapest suppliers reducing advantage of established firms

Evaluation

  • 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 price is the most important factor
  • 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.
  • 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.

See also: Are Monopolies always bad?

By on May 28th, 2008

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