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What Can Economics Learn From Marketing's MarketStructure Analysis?

by Charles C. Fischer

The concept of market structure is central to both economics and marketing. Bothdisciplines are concerned with strategic decision making. In decision-making analysis,market structure has an important role through its impact on the decision-makingenvironment. The extent and characteristics of competition in the market affect choice behavior among the actors [Baumol, 1961;Yadav, 1995]. The problem for economists and marketers is that a meaningful operational definition of market structure is elusive [See Horowitz, 1981;Belk, 1975.]. Each discipline takes a different methodological approach toward solving this problem, and each has its ownstrengths and limitations. Economics is concerned with broad socio-economic issues(e.g., market competition and fair pricing) as well as managerial, microeconomic problems (e.g., firm pricing strategies). Marketing, on the other hand, is more concernedwith the managerial aspects of market structure analysis. Each touches on the primarydomain of the other; the distinction between economic and marketing market structureanalysis is a matter of relative emphasis.This study is concerned with the contribution marketing market structure analysis (MSA)can make to economic MSA, and, more specifically, to the problem of market definition.It is argued that marketers have developed important MSA concepts and tools that couldstrengthen economic MSA. Though also important, in this article the potential benefits of economic MSA to marketing are not investigated.

Economic MSA

In economics, markets are classified according to the structure of the industry serving themarket. Industry structure is categorized on the basis of market structure variables whichare believed to determine the extent and characteristics of competition. Those variableswhich have received the most attention are number of buyers and sellers, extent of product substitutability, costs, ease of entry and exit, and the extent of mutualinterdependence [Baumol, 1982;Colton, 1993]. In the traditional framework, these structural variables are distilled into the following taxonomy of market structures:

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(1) Perfect Competition--many sellers of a standardized product,

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(2) Monopolistic Competition--many sellers of a differentiated product,

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(3) Oligopoly--few sellers of a standardized or a differentiated product, and

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(4) Monopoly--a single seller of a product for which there is no close substitute.These four market structures each represent an abstract (generic) characterization of atype of real market.Market structure is important in that it affects market outcomes through its impact on themotivations, opportunities and decisions of economic actors participating in the market.The goal of economic market structure analysis is to isolate these effects in an attempt toexplain and predict market outcomes [McNulty 1968;Broaddus, 1991]. MSA is concerned with the effects of competition upon economic behavior. It attempts to explainand predict market outcomes through the extent of market competition.A key element of economic MSA is product substitutability. Product substitutability isstrategically linked to market definition, a foundation element of market structureanalysis. Broaddus [1991], in his path-breaking research on the market structure of banking services, argued that "one cannot determine the structure of a market until themarket under consideration is carefully defined" [1991: 236]. This is a difficult task sincemarket definition is complicated by consumer perceptions of product substitutability.Broaddus, like other researchers, found no satisfactory solution to this problem. Horowitz provides one of the classic statements on this:Because economists from Adam Smith forward, have with confidence and enthusiasm,although not necessarily with shared views, written about markets, it is plausible that theywould have quite a bit to contribute to the resolution of the market-definition problem.Plausible but erroneous [Horowitz, 1981, 5].Today, it remains true that economics is better equipped to discuss markets (i.e., themarket analytic) than to discover them. Although much progress has been maderegarding the latter, which is crucial to MSA.The strategic role of product substitutability and market definition in economic MSA isillustrated in Figure 1. Product substitutability is linked to market definition, which, inturn, is integral to market structure. Figure 1 also calls attention to the importanceofmarket structure to competitive economic behavior.

In attempting to determine market boundaries,economists use product cross elasticity measures[going back to the pioneering work of Smits,1958].A market may be defined to include only a singlegood or a group of goods according to the followingcriteria: (1) a single good has a "low" cross elasticitywith respect to all other goods and thus constitutes amarket by itself, or (2) some group of goods have"high" cross elasticities among themselves, but"low" cross elasticities with respect to all other goods and thus collectively define a market.This approach works best when analyzing marketswhich approximate the market structure "end points"of perfect competition and monopoly. However, it ismore challenging to identify the market boundariesof markets well within these end points. Of issue iswhat constitutes appropriate criteria for differentiating between "close" substitutes within amarket and "distant" substitutes outside the market.Marketing MSA may be of some help in dealingwith this issue.In order to focus on the potential contribution of marketing MSA to economics, I haveisolated the role of cross-elasticity in economic MSA. It provides a bridge, if you will, between the two disciplines. There is more to Economic MSA than cross-elasticity as adeterminant of market definition. Yet, orthodox economic MSA is dominated by cross-elasticity analysis. The broader dimensions tend to be abstracted from (as discussed below) it.For those interested in the broader aspects of economic MSA, I suggest the followingimportant works: Greer [1993]--role of transportation costs and legal barriers as factors in determining market definition;Kirzner [1973]--importance of selling costs;Besanko, Dranove and Stanley [1996]--spatial analysis and cluster maps; Elzinga and Hogarty [1978]--trade flows; Stigler and Sherwin [1985]--price correlations; Baker and Bresnahan[1988]--residual demand analysis; Schwartzman [1973]--substitution gaps; Boyer [1979]--market share elasticities; Heyne [1994]--different levels of substitution;Lancaster [1971]--different levels of substitution. These and other market structurestudies by economists overlap with much of marketing MSA, but, because of thedifference in focus between the two, each has taken a different tact. It is in this light thatmarketing MSA may have something to offer economic MSA (and vice versa).

A Marketing Perspective

Marketing MSA offers some important insights into market definition. To investigatethis, an MSA framework is developed which attempts to distill and synthesize some key