Ruinous competition

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Ruinous competition is competitive behavior that is characterized by falling prices and thus insufficient profits or losses for the companies involved. The reasons for this can be found in strategic market battles by companies that are subordinate to the market against more cost-effective “newcomers” or “startups” and in disputes between cartels and outsiders. The consequences of this competition are lower investment activities by companies, the associated market exits and, in the long term, a disproportionate price increase due to the resulting market undersupply. The disadvantaged in this competition would therefore be the end consumers.

Basis of economic literature

Ruinous competition as a strategic market battle

In the microeconomic theory of H. Arndt (1966), ruinous competition is described as a market strategy. Companies that are already established on the market can use targeted price restrictions to drive cheaper competition from the market and prevent further potential competition. This could enable the company to achieve a dominant position.

According to Heuss (1965) the situation of ruinous competition relates to a struggle between cartel and outsider. The cartel is obliged to its members to secure the price and profit prospects and thus the continued existence of its members. To do this, it has to drive the outsider out of the market through a ruinous price war.

Further economic debates see the ruinous price war in the oligopoly (see Machlup (1967)). The reason for the assumption of the oligopoly is the need for a high degree of market power , which the established company must already have.

Ruinous competition as a delayed adjustment process

The delayed adjustment process is based on the assumption that “unit costs decrease when capacity is better utilized”. The unit costs are lowest when the capacity limit is reached. Should more cost-effective competition develop on the market, this would lead to a decline in demand from the established company, which would result in higher unit costs. The company will now try to prevent this decline in demand by undercutting. However, this means that the costs cannot be covered, which is why there would be ruinous competition there in the long term.

Heuss (1965) criticizes this approach, however, as it obscures the essential function of competition. According to the definition, this is intended to force producers with low-cost structures out of the market in order to achieve the highest possible efficiency on the market. Machlup (1967) also criticizes this view, since otherwise all competition would be fundamentally ruinous and prices would lose their function as a control mechanism.

According to Bain (1959), however, the price reductions are a sign of a market imbalance. This imbalance would result in "considerable economic real capital losses".

Reynolds (1940) differentiates ruinous competition from the struggle for market strategy by assuming that the price reductions of the established company only serve to increase profits in the short term through a disproportionate increase in sales. The problem of the crowding-out effect of competition would solve itself in the long term.

causes

conditions

According to Bain (1959), there are five mostly simultaneously existing conditions for the occurrence of ruinous competition:

Atomistic market structure of industry

With this market structure there is a maximum of independence from companies in determining price and quantity. Tolksdorf (1971) sees this as only a symptom of ruinous competition, not a real cause, since only the undesirable developments with quantity and price manipulation by companies are passed on to other industries.

Very easy market entry

According to Tolksdorf (1971), even easy market entry is only a symptom and not a cause of ruinous competition.

Very slow exit of companies from the market

Unusually slow exit of busy workers

Some historical events (e.g. war expansion with demand dropping to pre-war levels)

Factors (after Tolksdorf)

Immediately acting factors

Overcapacity

Tolksdorf (1971) sees overcapacity as the main cause of ruinous competition. The supply quantities, which were significantly higher than demand, resulted in supply and demand elasticities that were unfavorable for the producer, leading to a sharp fall in prices. Thus, there was no incentive for companies to restrict production. However, the collapse in prices caused by competition means that companies have no incentive to invest in assets for which there is no demand. In the long term, this would lead to a market exit and increased, concentrated market power of individual established companies. However, since this could also represent the natural control mechanism of the market, as Machlup (1967) already criticized, the factor immobility in the industry must also be taken into account. The overcapacity does not lead to ruinous competition on its own.

Factor immobility

Tolksdorf (1971) only deals with the factor immobility of the factor work historically. He sees the reasons for the persistence of the workforce despite lower wages due to the fall in prices (and thus loss) in the industry in a lack of better employment opportunities and in general transaction costs such as moving costs or a lack of education. Due to the lower wages, demand would not increase or even decrease, which would also offer companies lower sales opportunities in the long term.

The immobility of production capital must also be taken into account, as this prevented further investment by companies, since the capital already invested was not available with spontaneous market fluctuations. As a result of the drop in prices, no new production capital could be generated.

Indirectly acting factors

Technical progress

Technical progress meant that overcapacity could be maintained even in times of ruinous competition, despite major losses for companies. The technical efficiency led to a higher output of already existing production processes and machines.

Free entry to the market

The free market entry prevented the adjustment of capacities to a "healthy level", which could prevent ruinous competition. The overcapacity caused by newly created competition continues to intensify competition.

Macroeconomic Depression

The economic downturn boosted the decline in demand and thus further profit prospects for companies. An already existing ruinous competition is intensified by such a situation.

Emergence of substitute goods

The newly emerging substitute goods in other industries can lead to capacity exceeding the reduced demand, i.e. overcapacity to arise in the first place. The main reasons for the emergence of substitute goods are technical progress and more cost-effective (and therefore cheaper) production methods.

Traditional behaviors and entrepreneurial ineptitude

According to Tolksdorf (1971), employers' traditional, hopeful view of the future causes ruinous competition “by reducing factor mobility and maintaining overcapacity”. As long as the companies can cover the variable costs, they place their hopes on an improvement in the economic situation.

Strong fluctuations in demand and low price elasticity of supply and demand

The main focus here is on strong seasonal or annual fluctuations in demand. However, these are rather weak in their overall effect on the causes of ruinous competition. Small fluctuations in demand, however, resulted in a high price decline due to the low price elasticity. Examples of this can be found in agriculture and hard coal mining.

Labor unrest in the industry

Working days lost through labor disputes prevent capacity adjustments and thus lead to chronic misallocation of production factors.

Macroeconomic view and economic policy consequences

According to Tolksdorf (1971), the economic policy treatment of ruinous competition should be geared towards the economy as a whole due to the direct and indirect factors mentioned. The economic policy authority should therefore promote “regional structural policy, supplemented by a high level of employment and strong economic growth”. This should lead to the avoidance of factor immobility (in particular of the factor labor) and thus also avoid overcapacities.

Business consideration

From a company's point of view, the sales price is made up of variable costs and fixed costs . Fixed costs arise regardless of whether a product is manufactured or not, whereas variable costs only apply when a product is manufactured. The sales price of a product can drop to just above the variable costs, as it is more advantageous for a company to generate a small contribution to the fixed costs than no contribution at all . However, since the fixed costs also have to be financed when the generated contribution margins are not sufficient, it is not possible to operate at an arbitrarily low contribution margin in the long term.

The classic solution to this problem for the company consists in reducing fixed costs, which is regularly accompanied by a reduction in capacity . However, volume effects can be lost here, which in turn can permanently weaken the company's competitiveness . Alternatively, a company can temporarily accept losses in order to be able to sell again at prices that make a sufficient contribution to covering fixed costs after a reduction in capacity at competitors.

If so many companies in a market segment opt ​​for the latter strategy that the reduction in capacity remains lower than the fall in demand, the oversupply can only be eliminated by eliminating one or more competitors from the market. This then mostly happens through bankruptcy . Alternatively, buying up competitors or adjusting capacities as part of mergers are also possible .

Legal regulation

In most countries, competition policy tries to limit market strategy behavior through rules against unfair competition . In Germany there is the law against restraints of competition (GWB) and the law against unfair competition (UWG).

Delayed adjustment processes as entrepreneurial decisions, on the other hand, cannot generally be eliminated through state intervention.

literature

  • Ernst Heuss : General Market Theory . Tübingen and Zurich, 1965.
  • Fritz Machlup : The Economics of Sellers 'Competition, Model Analysis of Sellers' Conduct . Baltimore, 1952.
  • Fritz Machlup: Oligopoly and the Free Society . published in II Politico, Vol. 32, No. 2, 1967
  • Hans-Rudolf Peters : Economic Policy . Oldenbourg Wissenschaftsverlag, 2000, ISBN 9783486255027 , pages 191–192.
  • Helmut Arndt : Microeconomic Theory; Vol. 1, Market Equilibrium and Vol. 2, Market Processes. Tubingen, 1966.
  • Joe S. Bain : Industrial Organization . New York, London, Sydney, 1959, pp. 469-496.
  • Lothar Wildmann: Introduction to Economics, Microeconomics and Competition Policy . Oldenbourg, 2007, ISBN 9783486581959 .
  • Lloyd G. Reynolds: Cutthroat Competition . The American Economic Review, Volume 30, 1940.
  • Michael Fritsch , Thomas Wein, Hans-Jürgen Ewers : Market Failure and Economic Policy. Microeconomic foundations of government action . Verlag Vahlen, 2003, ISBN 9783800629435 .
  • Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development . Economic Writings, Issue 161 . Duncker & Humblot publisher. Berlin, 1971.

Individual evidence

  1. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 29 .
  2. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 30 .
  3. ↑ Michael Tolksdorf: : Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 29 .
  4. ↑ Helmut Arndt: Microeconomic Theory; Vol. 2, Market Processes . Tübingen 1966, p. 57 .
  5. ↑ Helmut Arndt: Microeconomic Theory; Vol. 2, Market Processes . Tübingen 1966, p. 232 .
  6. ↑ Ernst Heuss: General market theory . Tübingen and Zurich 1965, p. 222 .
  7. ^ Fritz Machlup: The Economics of Sellers 'Competition, Model Analysis of Sellers' Conduct. Baltimore 1952, p. 366 .
  8. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 31 .
  9. ↑ Ernst Heuss: General market theory . Tübingen and Zurich 1965, p. 187 f .
  10. ^ Fritz Machlup: Oligopoly and the Free Society . Ed .: Il Politico. Vol. 32, No. 2 , 1967, p. 264 .
  11. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 32 .
  12. ↑ Joe. S. Bain: Industrial Organization . New York, London, Sydney 1959, pp. 469-496 .
  13. ^ Lloyd G. Reynolds: Cutthroat Competition . In: The American Economic Review . tape 30 , 1940, p. 736 .
  14. ^ Joe S. Bain: Industrial Organization . New York, London, Sydney 1959, pp. 474 .
  15. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 87 .
  16. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Berlin 1971, p. 87 .
  17. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 89 .
  18. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 92 ff .
  19. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 94 .
  20. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 95 ff .
  21. ↑ Michael Tolksdorf: A contribution to the phenomenology and competition policy treatment of a market economy undesirable development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 98 ff .
  22. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 101 .
  23. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 103 f .
  24. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 104 .
  25. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 105 f .
  26. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 111 .
  27. ↑ Michael Tolksdorf: Ruinous competition. A contribution to the phenomenology and competition policy treatment of a negative market economy development. Economic Writings, Issue 161 . Verlag Duncker & Humblot, Berlin 1971, p. 111 .