Why markets matter

Business is a game with many opponents and possible moves. When you can anticipate your opponents move in any game, you can gain an advantage.

This is the heart of game theory. Markets are a factor to understand what game you are playing, and how your opponent might move.

Let’s first explore the kinds of markets there are, and how they impact strategic product management decisions.

Perfectively Competitive

This is typically reserved for commodities, such as rice, sugar, and other raw materials. The goods themselves (at least in bulk) have zero differentiation and buyers primarily rely on price, supply and service to select them. Few software segments would exist in this category; we list it to better understand the others.

Monopolies

A monopoly is defined as a market for which you have no other choice in providers. This is often related to areas with extremely high entry costs, such as utilities like electricity and water. Many true monopolies are owned by government, or privatised in such a way you have little choice in who you buy from. This is to protect their profits and thus repay the large entry barrier, as well as guarantee ongoing service. Again, few software categories could be considered true monopolies. Apple could be said to have a monopoly over their own App Store, however consumers are not limited to only using Apple products. Windows has a near monopoly over PC, however there are other operating systems.

Commodities and monopolies are very black & white; software typically lives in the grey space in between.

Monopolistic Competition

Defined as a market where each Product is differentiated, however entry and exit is relatively cheap.

Task-tracking software could be considered in this group. To create a ‘Trello-clone’ – a simple Kanban board with cards – would be fairly cheap as far as software goes.

Many app store games are relatively cheap to produce and somewhat commoditised. You may have preferred utilities like calculators, notes and bill-splitting apps. However few of these could command a large premium.

However it would remain ‘monopolistic’ in the sense that each company owns it’s differentiated brand; some consumers may pay more for Trello, just in the way they might pay more for Colgate toothpaste; however not too much more. This separates it from being neither a total monopoly nor a perfectly competitive market.

‘Free entry’ is also an important characteristic of these markets. It effectively caps prices. If any one app was making too much money, a high number of competitors will enter trying to capture some of the market share. These entrants will often undercut incumbents to steal share, and there is only so much premium that someone would pay for a digital Kanban board.

Oligopolys

Oligopolys are similar in the sense that there is an element of monopolistic power through brand and product differentiation (though not too much). The difference is in the entry price. Automobiles are the classic example here. Even if car makers were making modest profits, it is so expensive to bring a new manufacturer to market, that it doesn’t happen often.

Certain medical software could be considered in this category. There are multiple regulatory, privacy, compliance and technical overheads involved. The market size is also a niche. This effectively raises the barrier to entry for new entrants.

What are some other examples

  • Netflix, Hulu and Stan
  • Uber, Lyft and Grab
  • Samsung, Google and Apple
  • Microsoft and Apple
  • Amazon and AliBaba

What does all this mean to how the firms interact?

In a monopolistic market, firms can rarely cooperate and raise price, and the importance of differentiation and raising switching costs is critical. Having a defined position that you can increasingly deepen over time is the way to ‘change the game’ here.

Oligopolies are quite different here. A couple of major firms in any oligopoly could cooperate and raise prices together (putting aside for a minute this collusion is typically illegal). With the barrier being effectively too high for new entrants, it would mean higher profits for everyone. If Samsung and Apple both raised prices by $100, very few would switch to an Oppo phone, and all the shareholders would be happy.

So why doesn’t this happen? To understand, we need to go deeper into game theory.

References

Pindyck, R. and Rubinfeld, D. (2012). Microeconomics. 12th ed. Upper Saddle River, N.J.: Pearson/Prentice Hall.

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