1Automobile Industry

Automobile Industry

1. Market Model

Automobile is one of the industries that have experienced changes in its market model in

the last five decades. The automobile industry is one of the world’s most essential economic

sectors (Nag, Banerjee & Chatterjee, 2007). This industry involves the manufacture,

development, design, marketing and selling of vehicles. The industry was established in 1886

after Karl Benz built the first practical vehicle. In the early periods the industry was

characterized by huge manufacturers who were responsible for most of production activities

including; design, manufacture of parts, assembling, marketing and selling (Nag, Banerjee &

Chatterjee, 2007). In the industry’s pioneering era, there was a lot of protectionism. Different

countries protected there automobile manufacturers through import bans and high tariffs. This

resulted in limited competition within the industry and the creation of a monopolistic market

model. However, the market structure changed in the second half of the 20th century. The

changes were introduced by the liberalization of the major economies of the world.

Elimination of protectionism introduced competition within the automobile industry.

Many players joined the industry leading to further competition and the creation monopolistic

compensation. In the 1980s, competition in the automobile industry was at its peak as companies

priced each other out of the market (Nag, Banerjee & Chatterjee, 2007). Companies could no

longer sustain the price battles as they had exhausted all avenues for improving efficiency. This

situation was compounded by changes in labor and consumer markets. Many companies found it

increasingly difficult to operate. In the 1990, the market model began to change as the

automobile companies began to merge. Chrysler merged with Benz; Kia merged with Hyundi;

while Ford acquired Volvo, Jaguar and Mazda (Hashmi & Biesebroeck, 2009). Consolidation led

2Automobile Industry

to reduced competition within the industry. It also made it difficult for new company to enter and

survive in the industry. This scenario resulted in the creation of an oligopolistic market model.

The oligopolistic market was sustained further by the specialization within the industry.

Different manufacturers have specialized in producing vehicles for specific market niches thus

reducing competition (Hashmi & Biesebroeck, 2009). Firms have also specialized in terms of the

level of production with each firm opting to operate with one level. Some companies have

specialized in production of parts; others specialize in assembly; others in design; while others

deal solely with marketing and selling. This has further eliminated competition within the

industry.

2. Short Term and Long Term Behavior

Oligopolistic market model place more emphasis on differentiation rather than price

competition (Dune & Klimek, 2011). Automobile companies are trying to increase market shares

in the short term through various differentiation strategies. These strategies include making

stylish models; making fuel efficient vehicles; increasing safety and durability and marketing.

There is a general tacit collusion when it comes to setting prices. This is where players do not

change their prices because they fear that competitors will respond by also cutting prices. Since

the players in the oligopolistic markets are large, they cannot change their in strategies easily,

especially prices (Dune & Klimek, 2011). This tacit collusion has resulted in higher margins for

the companies and consequently higher profits.

The players in the automobile industry are likely to maintain abnormal profits in the long

run. This is because the oligopolistic market is characterized by high entry barriers (Dune &

Klimek, 2011). New players have little chance of entering and surviving in this market. Thus,

lack of new entrants in the market is likely to have little impact on prices and, therefore, existing

3Automobile Industry

firms are likely to continue enjoying the same level of profit. The only factor that will affect

prices in the industry is demand. Demand many be influenced by changes in population and the

purchasing power of the population.

3. Transactional Cost

Transactional cost is the cost associated with maintaining business relationships with

independent parties (Tedelis & Williamson, 2010). One of the areas that could result in

transactional cost for the automobile companies is the acquisition of supplies/ input. The

automobile industry has become very specialized in terms of level of production. Today, parts

are produced by different firms and supplied to the auto manufacturers for assembly. Contracting

independent companies to produce and supply parts rather than having brand manufacturer

producing the parts, has resulted in high transactional cost (Tedelis & Williamson, 2010). These

transactional costs include the cost of switching, costs of governance, transportation, inspection,

and inventory.

The second area in which the automobile companies incur transactional cost is marketing

and selling (Tedelis & Williamson, 2010). Most automobile manufacturers do not market and

sell their brands directly, but depend on dealers in various markets to sell their products. This

distribution model is a major source of transactional cost. The third source of transactional cost

is financing (Tedelis & Williamson, 2010). Most automobile firm depends on external entities to

handle their financing issues. These companies often depend on equity, loans and bond to

finance their activities. This means that the have to deal with external entities such as; banks; the

stock exchanges; finance consultant and many others. Dealing with financial institutions

increases the transactional cost as the financial institutions must make money from their

relationship with the automobile firms.

4Automobile Industry

4. Behaviors that Could Result in Transaction Cost

One of the behaviors that can results in increased transaction cost is high specialization

within the industry (Tedelis & Williamson, 2010). High specialization is likely to lead to many

and complex vertical and horizontal relationships within the industry. Another behavior that is

likely to increase transaction cost is opportunism (Tedelis & Williamson, 2010). Subcontracting

of independent companies in order to get essential inputs or services can expose the firm to

opportunism by the suppliers. The suppliers may issue the products or services at higher prices

with the aim of making higher profits. One way of dealing with this behavior is to establish

effective governance structures. Another strategic way of dealing with these behaviors is

establishing close and long term relationships with the suppliers. Legal contracting is also an

effective strategy for dealing with opportunism.

5. Factors that Affect Competitiveness

One of the factors that affect the level of competition in the industry is the number of

competing firms. High concentration in an industry results in fierce competition which leads to

drop in prices (Nag, Banerjee & Chatterjee, 2007). The automobile industry was previously very

competitive as it consisted of many players. Today, competition has reduced due to mergers

between competing firms. Another determinant of competitiveness is the size of the market. A

bigger market results in lower level of competitiveness, since there is adequate demand for every

player (Nag, Banerjee & Chatterjee, 2007). The market for automobile products is gradually

expanding, with the expansion being driven by growth in population and increased purchasing

power of consumer. Consequently, each firm is establishing its own niche in the market resulting

in reduced competitiveness.

5Automobile Industry

References

Dune T. & Klimek S. (2011). Entry, Exit and the Determinant of Market Structure. August 28,

2012. http://www.econ.psu.edu/~mroberts/dkrx-rev.pdf

Faille C. (2010). Revenue Forecasting Methods. August 27, 2012.

http://www.ehow.com/list_6869859_revenue-forecasting-methods.html

Hashmi A. & Biesebroeck J. (2009). “Market Structure and Innovation: The Automotive

Industry”. August 15, 2012.

http://www.cepr.org/meets/wkcn/6/6679/papers/vanBiesebroeckFinal.pdf

Jerenez A. (2008). Revenue Management and Survival Analysis in the Automobile Industry.

USA. Springer Publishers

Nag B. Banerjee S. & Chatterjee R. (2007). Changing Features of the Automobile Industry in

Asia. August 15, 2012. http://www.unescap.org/tid/artnet/pub/wp3707.pdf

Tedelis S. & Williamson O. (2010). Transaction Cost Economics. August 28, 2012.

http://faculty.haas.berkeley.edu/stadelis/tce_org_handbook_111410.pdf