Perfect Competition - a myth?

Perfect competition market is one of the four market structures known to man, the others namely monopolistic competition, monopoly and oligopoly markets structures. This paper will explore perfect competition market and how its conditions affect Project Based Firms. Perfect competition is a market place for anybody. The number of firms that operates is always high unlike other markets, to cope up with the market the products are almost similar and standardised with key technical changes to make the product different from what is available. The reason for a large number of firms in the industry is due to the fact that there is no entry or exit barriers in the market.

Since, the competition is immense the concentration ratio for a single firm among the market will be zero. In a perfectly competitive market, there is no control over the price of the product in market. The extent of control over price is determined by the concentration ratio which is determined by the number of firms in the market.

Though perfect competition is hailed as the perfect market place for any enterprise or industry, it is often criticised by economists as a place where the producer can not determine prices and the prices which are determined by the demand and supply.

Literature investigated on competitiveness in construction industry and concluded that the construction industry imposes a lot of characters within itself which made research and understanding of the construction market difficult. Competitiveness in construction market has a lot of definitions, this serves as an example for the diversity and complexity of the topic on the whole. Defining competitiveness opened the forum to research on the core meaning of construction industry. Competitiveness’s importance is not only because of the growth it has seen and the influence it has in the country’s GDP but also from the increasing competition that the firms face in the industry. Construction industry’s competitiveness can be understood in different levels, namely Nation, Industry, Organisation and the project level. The construction industry is an industry where all firms within does something related to each other and compete with each other in the process.

The construction industry from the outside by economists are seen as a patched, uneven and competitive industry. As touted by economists in the early 20th century, due to globalisation, the bigger firms will create a wider spectrum and the smaller firms will be bigger even smaller, the gap between them will be get wider over the years. Though the grouping and its relevance is complex, the construction industry in the UK is seen as straightforward.

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Size matters

Perfect competition and competitiveness of the industry has always been on firm-level and the focus has failed to widen even though this has been a key topic in the Construction and Project Management literature. LEs (Large enterprises) have always been the most influential and tend to overlap SMEs’s (Small and Medium Enterprises) perspective on industry economics and this one of the many reasons why the study has been limited. The emphasis on the LEs is understandable as they were the central focus of the business models that were structured in the 1990s for its power to influence markets on the whole.

As a matter of fact, in almost all countries not only the UK, the number of small firms has been the majority but is often ignored due to its inability to affect the industry individually but on the whole the SME’s competitive attitude is important for competitive sustainability and any country’s economy.

SMEs dominate the construction industry on practical terms and will continue to do so because (i) Projects done by SMEs are suitable for them and LEs do not compete in the market for small projects. (ii) The skill set required for the small projects is relatively small and that breaks the barrier of entry. (iii) In a small sub-industry which operates on projects, ‘smallness’ and ability to differ in flexibility levels is a huge plus. (iv) SMEs construction require operation and maintenance opening a wider sub-industry which is occupied by very small contractors. Though SMEs do not influence the markets much as the LEs, they are major source of employment and have a major impact in the local economies.

The models that focus on LEs can not work for SMEs as they differ in all managerial and financial levels. What made the paper focus on this subject for perfect competition is, the importance of understanding SMEs because they’re more than two-thirds of the firms in the industry. But how do you classify SMEs and LEs? A number of authors differentiated firms on the the basis of their structure of demand, competitors and their size of growth. Few economists also mentioned technological investments as a major criterion for classification.

Is it really perfect competition?

The industry due to no entry barriers is filled with small firms, which makes the industry fragmented and patched. The large contractors in the UK like Balfour Betty, Kier, Interserve, etc have influence on the way the market is structured, they do not face competition from SMEs that are working on small projects. So, in perfect competition everyone has a say in the market and when only few firms have a say in the market, it becomes an oligopolistic market. In an oligopolistic market there are only few firms that are operating and the growth is seen as a barrier to entry. Pre-qualification is one major deciding factor that decides the market structure. The concentration ratio is now high due to the fact that there are only few large firms to select from. This oligopolistic competition throws light competition by unique category of work. The only firms that are in perfect competition are the small size firms, even the medium sized firms act between these two markets. They become sub-contractors for the large firms in specialisation in the work they do. For example, HVAC systems and security operational systems. This market becomes monopolistic. These medium sized firms benefit from both the markets.

Porter’s five force model

Porter generally labelled five important factors that will affect any market for any industry. This is suitable for the construction industry, this has been labelled as an important factor in any paper or research revolving around competitiveness.

Acar 2006 came up with five questions that is very important for all project based firms.

1.Is the firm’s service very important that the client can not replace it?

2.Does the firm know what the client wants?

3.Can the firm substitute their own suppliers?

4.Does new entrants threaten the firm?

5.Can the firm determine rival’s future course of action?

Porter’s factors must be understood by strategic managers of individual firms to understand the needs and competitiveness of the market. (i) Buyer power (ii) Supplier Power (iii) Rivalry (iv) New entrants (v) Threats of substitutes.

Bargaining power of Buyers

Any small medium enterprise has two types of clients, (i) New client (ii) Client who holds previous relationship with the firm. The bargaining power of the client is moderately less in a speculative market, as the client is unknown, and the project is been made for any client. In a normal, contractual market, the price of the building, characteristics and the profit of the SME is pre-determined. Beneath money and the value, what lies and makes the client go to the contractor again is the trust. In a speculative market, there will be a lot of fluctuation in demands, economic crisis, shift in trends and needs of the people. So, the buyer has a say in a perfectly competitive market, where there are a lot of other competitors who would satisfy the clients with a similar/better price.

(ii) Bargaining power of suppliers

The construction industry has a poor structure both in organisational behaviour and technical aspects. With the building industry requiring more than one contractor involved in the process, the decision-making capacity is held by three parties; the supplier, the project based firm and (indirectly) the client.There are a number of suppliers for a single sub-system, meaning the bargaining power of the supplier is relatively low in any market unless there is a demand in the specific specialisation that the supplier has to offer. UK contractors usually switch suppliers after few projects as the supplier may abuse the trust of the contractors, which is very harmful for the supply chain. But others few other remain with the same suppliers even though they are not happy with the product or service due to non-material benefits and long standing relationship.

(iii) Degree of rivalry

The construction industry is always known for its high competition in all levels, right from LEs to SMEs. The high degree of rivalry is mainly due to the fact that the products are similar and every project based firm acquire the skills required. Fluctuation in market is also an important factor that results in high competition in a perfectly competitive market. Also, the inelasticity of the supply in land is a major issue. In a small market, the needs of all clients align to the same line and the information gets passed on to the competitors.

In a small market, everyone does the same thing and these firm when supported by local authorities can bring in more projects. Pre-qualification and skill ability is often ignored when the competitors have the advantage of local authorities.

(iv) Threats of new entrants

With no entry and exit barrier, the construction industry gets in a huge number of firms every year. With plants and machines available for low rentals, low investment requirements, lack of any legal constraints and help from sub-contractors are the reasons for the entry of many SMEs.

This results in high degree of rivalry. But, majority of the firms that enter with minimal investment do not survive in the industry due to low profits due to the increase in competition. With the number of clients relatively the same, already existing firms get the advantage of trust. As mentioned above, support of local authorities is key for survival in the industry. As a new entrants fail to survive, another old firm gets more credit and a forum to establish new client relationship.

(v) Threats of substitutes

In construction industry, there is no substitute. For a building, there are no alternatives. But the process and differentiation is shown through technology and way of construction. What can change is the types of buildings that firms of different capacity undertake. In the UK, there are small firms that still operate with bricks and concrete made in the site. However many LEs use precast concrete and fabricated slabs for construction.

Pre-qualification

Why does the majority of the SMEs do not make it as a LE? The simple answer to that is that they do not possess the experience and qualification that would make the client trust their work or skill. Due to the number of risks involved in mega projects, clients prefer working with the same contractors even if they don’t have a satisfactory relationship. Though the industry labels itself as a perfectly competitive market, small details like pre-qualification and oligopolistic behaviour of large firms makes it difficult to understand the concept better.

SMEs although without any entry barriers, suffer in the hands of pre-qualification, this is now the most important entry barrier in the industry. Only the large firms have the capacity of operating and managing mega projects, and their relationship with the client is also an important pre-qualification factor.

The market being widespread, the meaning of client relationship, differs from a SME and a LE. Client relationship and development of trust in one of the most important things for a SME.

Though sub-contractors often tend to misuse the trust of the firm, their relationship explained by many firms as marriage, goes on even if the one of the parties are unhappy. Local market’s basis of client relationship is the mutual trust with the firm they possess.

Input structure of construction

Maharajan 1997 classified various groups and put together an input structure which will serve the construction industry on the whole.

(i)Materials and Components

(ii) Industrial Self-input

(iii) Professional consultancy

(iv)Plant and equipment

(v) Real estate

(vi) Transport and other services

(vii) Energy and other supplies

These seven groups acts as intermediates in the construction sector. These are the inputs that is required by every single industry. All these industries are connected by the construction industry and are heavily concentrated. There are low concentrated markets such as professional consultancy, services and timber.

Hence, construction industry is a mixture of both sub-contracting firms which are heavily involved on the industry on the whole and project based firms in depth. Fluctuating in demand and supply, behaviour of firms and market structures are the key issues that are concerned with the seven grouped firms.

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Conclusion

The construction industry though comprising different categories of project based firms, is relatively competitive when compared to other sectors. The major problems that the competition faces are the very fact that there is inequality in the way the market operates. The SMEs do not have a say on the prices, they are affected when there is a crisis and most of these firms are the ones that look to survive and make minimal profit. In UK, the leading 10% of the firms, produces humungous profits. The SMEs in the UK, suffer in the hands of these LEs. Though the market is perfectly open for competition, the economic graphs of the LEs and SMEs show huge variations.

The tail of this industry is huge when compared to the big head. Very rarely does a SMEs go beyond the stature and become a LEs. Most of these SME fizzle out of the industry or work on very less profit margins. But a high growth industrial environment will never discourage entrants, a low one will . This affects the economy, but the SME is a huge employment generating group by themselves. Though there are no entry barriers in the industry, the industry on the whole has few factors with which a firm can operate. Prequalification, Relationships with clients and support of local authorities.

It is fair to say that the industry is not perfectly competitive and economically inefficient. These two groups can not be matched and it is different ball game when it comes to how it is structured and how the projects are worked out. The market is oligopolistic according to many economists, the paper’s attitude on the topic has always been to that shore. The small and medium enterprises have perfect competition while the big firms enjoy less competition and collusion being prevalent in the tendering process.

In construction industry, there are no scope of substitutes. A substitute of a building is another building. The substitutes which are new to the market is used and operated in mega projects usually, mega projects are done by LEs, due to pre-qualifications. The only substitute that SMEs get are from the intermediate firms that in monopoly with their specifications and specialisations.

According to BERR, 2006 99.8% of the firms in the UK, employ less than 50 staffs. To be put into numbers, there are 296,093 firms in the UK, out of which only 291 host more than 300 employees, meaning only 291 are Large Enterprises. These 0.2% account for more than 15% of the revenue among the overall turnover of the industry. This proves that the fact that these LEs influence market prices, SMEs are considerably very important for the industry’s and the country’s growth.