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What Can Economics Learn From Marketing's Market Structure Analysis?

by Charles C. Fischer

Charles C. Fischer is a Professor in and the Chair of the Department of Economics, Finance, and Banking, Pittsburg State University. He is also the Editor-in-Chief of the Journal of Managerial Issues.

The concept of market structure is central to both economics and marketing. Both disciplines are concerned with strategic decision making. In decision-making analysis, market structure has an important role through its impact on the decision-making environment. 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 own strengths 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 concerned with the managerial aspects of market structure analysis. Each touches on the primary domain of the other; the distinction between economic and marketing market structure analysis 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 could strengthen 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 the market. Industry structure is categorized on the basis of market structure variables which are believed to determine the extent and characteristics of competition. Those variables which 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 mutual interdependence [Baumol, 1982; Colton, 1993]. In the traditional framework, these structural variables are distilled into the following taxonomy of market structures:

These four market structures each represent an abstract (generic) characterization of a type of real market.

Market structure is important in that it affects market outcomes through its impact on the motivations, 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 to explain and predict market outcomes [McNulty 1968; Broaddus, 1991]. MSA is concerned with the effects of competition upon economic behavior. It attempts to explain and predict market outcomes through the extent of market competition.

A key element of economic MSA is product substitutability. Product substitutability is strategically linked to market definition, a foundation element of market structure analysis. 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 the market under consideration is carefully defined" [1991: 236]. This is a difficult task since market 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 they would 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., the market analytic) than to discover them. Although much progress has been made regarding the latter, which is crucial to MSA.

The strategic role of product substitutability and market definition in economic MSA is illustrated in Figure 1. Product substitutability is linked to market definition, which, in turn, is integral to market structure. Figure 1 also calls attention to the importance ofmarket structure to competitive economic behavior.

Figure 1In 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 single good or a group of goods according to the following criteria: (1) a single good has a "low" cross elasticity with respect to all other goods and thus constitutes a market 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 markets which approximate the market structure "end points" of perfect competition and monopoly. However, it is more challenging to identify the market boundaries of markets well within these end points. Of issue is what constitutes appropriate criteria for differentiating between "close" substitutes within a market and "distant" substitutes outside the market. Marketing MSA may be of some help in dealing with this issue.

In order to focus on the potential contribution of marketing MSA to economics, I have isolated 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 a determinant 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 following important 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 structure studies by economists overlap with much of marketing MSA, but, because of the difference in focus between the two, each has taken a different tact. It is in this light that marketing MSA may have something to offer economic MSA (and vice versa).

A Marketing Perspective

Marketing MSA offers some important insights into market definition. To investigate this, an MSA framework is developed which attempts to distill and synthesize some key aspects (certainly not all) of the marketing literature on MSA.

Proposed Framework

Marketing MSA, like economic MSA, focuses on the strategic concept of market definition. Defining the market is the first and crucial stage in the analysis of competitive market relationships [Ganzach and Karashi, 1995; Arndt, 1979; Buzzel, 1978; Day et al., 1979; Bourgeois et al., 1980]. Marketers view market definition from three different perspectives:

Figure 2Under the substitutability criterion (lower left element in Figure 2), products are considered competitive if consumers perceive they may be substituted for some purpose(s) [Warshaw 1980; Sashi and Stern, 1995; Fraser and Bradford, 1983; Lattin and McAlister, 1985; Srivastava et al., 1981]. The market is defined to include only products having common purposes. In this variant of marketing MSA, product purpose is the organizing theme for analyzing competitive relations among firms.

This view of market definition seems to reflect economists' concerns about product substitutability and firm interrelatedness. However, overall, marketing MSA differs in two important aspects of market definition: (1) it places less emphasis on objective cross elasticity measures than does economic MSA, and (2) marketing MSA emphasizes a multidimensional view of substitutability, in contrast to the prominence of unit dimensionality of cross elasticity in economic MSA. This is illustrated by the different avenues of marketing MSA depicted in Figure 2, with the objective (cross elasticity) approach on the left side, the subjective on the right, and hybrids of the two in the middle.

Further, marketers emphasize different levels (dimensions) of substitutability. They see products competing in ascending or descending product purpose domains [Guillinan, 1993]. For example, a particular brand of toothpaste may compete with another brand at the "lowest" level of competition (most narrowly defined set of purposes); with other dental hygiene products (e.g, tooth powders) at the next level, mouth "fresheners" (e.g., breath mints) at a higher level, etc. This has strategic importance for marketing management. For example, an advertising campaign by a toothpaste manufacturer to lure consumers away from tooth powders would be very different than one aimed at a competitor's brand of toothpaste. This underscores marketing MSA's emphasis on managerial issues.

In this variant of marketing MSA (right side of Figure 2), product market definition depends upon the level of product substitutability. Each level of substitutability may yield a different market definition, which, in turn, may lead to a different market structure. For marketers, there is no "true" market definition and thus there is no true market structure "out there" [Lovelock, 1983; Dick and Basu, 1994; Srivastava et al., 1984]. This is a key theme in marketing MSA.

Alternatively, markets may be defined behaviorally (left side of Figure 2). The behavioral approach is based on market impact [Garda, 1981; Murphy and Enis, 1986], as measured by product cross elasticity [Shepard, 1974; Shocker et al., 1990; Cooper, 1988]. Here, the product itself, rather than product purpose, is the organizing theme for analyzing competition. Of interest are those products whose sales have been significantly affected by marketing strategies related to other products [Katabe and Duhan, 1993; Garda, 1981]. Gaps or discontinuities in these effects form the basis for identifying the boundaries of the market (i.e., defining the market).

The distinction between substitutability and market impact is useful for marketing MSA; however, in reality, the two are related. A product which shares similar or related purposes with other products (i.e., is substitutable) often will be significantly affected (market impacted) by firm marketing strategies [Arabie et al., 1981]. Yet the two approaches may not provide the same insights. Consider brand loyalty. In the case of customers who are loyal to one of several products that have a common purpose, market impact measures of competition may conceal the potential for product substitutability among those products. Brand loyalty may hold firm within the existing range of competing product prices, but will likely collapse at some greater price differential [Dick and Basu, 1994; Slater and Narver, 1994].

Marketers thus face a dilemma in their MSA: it is useful to derive market definition from either substitutability or market impact criteria, but there exits areas of competitive behavior which neither approach alone is well suited to analyze. To remedy this, marketers have developed hybrid forms of MSA [See the pioneering work of Green and Tull, 1978; Grover and Srinivasan, 1987.]. Hybrid approaches further underscore the notion that there is no "true" market structure [Hyman et al., 1995; Shocker et al., 1990]. In marketing MSA, market structure is relative to the fundamental approach used for defining the market--behavioral, judgmental, or a hybrid of the two.

Hybrid methodology combines behavioral and judgmental market definition criteria, as well as other elements in subsequent stages of marketing MSA (II and III in Figure 2, discussed below). Different integrations of these elements may yield different market structures. This is particularly true regarding the aggregation issue.

In deriving the overall market structure, individual consumer market structures are aggregated [See Pacheo, 1989; Grover and Rao, 1988]. The individual structures are each customer's behavior or perceptions regarding the marketing variable(s) of interest. There are two main aggregation methodologies employed in marketing MSA: (1) behavioral aggregation, which is linked to market impact definitions, and (2) subjective aggregation, linked to substitutability. The aggregation issue is problematic. How does one meaningfully aggregate individual consumer choices, which, as a group, often reflect considerable diversity with respect to the defined product domain [Greenley, 1986; Powers and Trawick, 1993; Belk, 1975].

The aggregate market structure may not be representative of individual structures. The overall market structure, at best, only provides an average of consumer diversity. Average measures tend to hide much information, and may even be misleading. This is a limitation of any MSA.

Once individual consumer behavior has been aggregated and quantified (Stage II), however imperfectly, the next step is to develop an operational representation of the aggregate structure (Stage III). The goal is to represent inter-product competitiveness in a manner that effectively conveys its research and managerial implications [Elrod, 1988; Hyman et al., 1995; Arabie et al., 1981; Bonoma and Crittenden, 1988].

Two main representation approaches are used in marketing MSA--spatial and nonspatial. Spatial techniques tend to be associated with judgmental data since they are well suited for continuous dimensional market structures [Masaaki and Duhan, 1993 ]. At the simplest level, spatial techniques portray (i.e., provide a "picture" of) market boundaries as separate clusters of products in two dimensional space (products and distance). A judgment must be made regarding distance between clusters as a determinant of market boundaries. Nonspatial representation is better suited for representing behavioral data because of their discrete, categorical properties. For example, cross-elasticity analysis is based on the actual behavior of consumers.

Behavioral and judgmental data are not mutually exclusive, and may in fact provide important insights when combined [Miles et al., 1993]. Thus, hybrids of spatial and nonspatial representations have been developed. A commonly used hybrid is an overlapping cluster map. Each cluster itself is nonspatial, but the clusters are displayed spatially.

Stage IV, the final stage, concerns the incorporation of market structure representation in marketing management decision making (see Green and Tull, 1978; Greenley, 1986; Dick and Basu, 1994; Lee et al., 1987; Stefflre, 1968). This is well beyond the scope of this article. Of interest here are the insights the marketing MSA framework (leading up to Stage IV) has for economic MSA.

Contribution of Marketing MSA to Economic MSA

In this section we explore the potential contribution of marketing MSA to economic MSA with respect to: (1) the underlying (implicit) foundations of economic MSA, and (2) the application of MSA in managerial economics.

Underlying Foundations

Marketing MSA, by emphasizing and treating explicitly various elements subsumed (in the explanans) in economic MSA, reveals some of the underlying foundations of economic MSA. This methodological juxtaposition reflects a unique MSA agenda within each discipline, and facilitates a better understandings of the strengths and limitations of each and how economic MSA may be strengthened.

Marketing MSA focuses almost exclusively on consumer behavior. Economic MSA is concerned with a broad and diverse range of market performance as well as social issues. This calls for a high level of abstraction and simplicity (in the spirit of William Occam's "razor"). In contrast, marketing MSA strives for a tight methodological focus and managerial specificity. Consequently, it does not possess the general analytical fertility found in economic MSA.

With its more focused methodology, marketing MSA incorporates factors not explicitly treated in orthodox economic MSA. For example, marketing MSA is concerned with both the underlying determinants and the dynamic of consumer preferences. Economic MSA, in pursuing general fertility, avoids such complexities by treating them as "given" (e.g., consumer preferences) and/or by simplifying the environment through the use of "as if" assumptions (e.g., perfect information). "As if" assumptions are useful for distilling complex economic phenomena into manageable models, approximating real-world economic processes, and evaluating actual economic processes in terms of their deviation from ideal states. Joan Robinson [1973] coined the notion of "as if" analysis as "useful fiction," if well understood and used appropriately.

The usefulness of economic fiction depends on an understanding of that fiction. In economic MSA, this concerns the specification of the ceteris paribus statement or explanans (initial conditions). However, in economics (any social science, as well as astronomy) complete specification is not possible [See the pioneering work of Hempel, 1942]. Keeping this limitation in mind, marketing MSA may be of value by providing insights into the nature and implications of the initial conditions of economic MSA that are not apparent in economic MSA.

Marketing MSA uses a process, multi-stage methodology (as depicted in Figure 2), which makes explicit the underlying conditions of a particular market structure (in contrast to the taxonomic methodology of economic MSA). For example, marketers may treat consumer preferences as the variable of interest, deriving market structure subjectively. In so doing, Marketing MSA reveals both the sources and dynamic of consumer preferences and how they can affect market structure. Generally, that which marketing MSA treats explicitly is part of the environment in economic MSA. As such, it helps illuminate the useful fiction of economic MSA, as conceptually set forth in the ceteris paribus conditions and explanans.

Of interest here are marketing MSA's insights into the elusiveness, complexity, and instability of market structures. A conclusion of marketing MSA is that there is no "true" market structure "out there" [Grover and Rao, 1988; Powers and Trawick, 1993]. While it is useful to assume particular market structure prototypes for analytical purposes, as is done in standard economic MSA, marketers must confront the conditional and elusive nature of market structure in attempting to operationalize MSA (regarding type of data, method of aggregation, dimensional representation, etc). From an operational perspective, any particular market structure may shift suddenly. In the case of behavioral measures of product-defined markets, market structure may shift due to actual and/or perceived changes in the product itself. In purpose-defined markets, customer perceptions of product substitutability and related market structure may shift rapidly (e.g. the almost overnight sensation of oat bran as a "health food").

In Economic MSA, these issues are (both explicitly and implicitly) abstracted from, becoming part of the useful fiction. The contribution of marketing MSA here lies in the insights it provides into the nature of the fiction of economic MSA. Consider, for example, in the market analytic, the fiction of a stable demand curve is made useful by the specification and understanding of its certeris paribus statement. It is well known in microeconomics what variables may impact demand and what happens to demand when any of them change. In contrast, the initial conditions of economic MSA are not thoroughly specified. Marketing MSA may contribute toward a more complete specification. For example, market MSA indicates that a particular market structure is based on how individual market structures are aggregated. Though important, this does not emerge from economic MSA, given its methodology. By default, it is part of the implicit, unspecified explanans of economic MSA. Similar reasoning can be applied to other variables of interest in marketing MSA (e.g., the role of consumer perceptions in subjectively defined markets).

Part of the contribution of marketing MSA is methodological in the sense of illuminating the environmental variables lying in the background of economic MSA. This is important to understanding the nature of the useful fiction of economic MSA, and it is important to the application of economic MSA, as the following discussion of managerial economic analysis demonstrates.

Economic Analysis

Marketing MSA is inherently managerial, emphasizing the relationship between firm behavior and market structure. In the words of Baker, "the firm's definition of its industry and its market will be critical to the formulation of its own competitive strategy and the success or otherwise of this strategy" [Baker, 1985, 45].

Economists also are interested in the relationship between the firm and market structure. Economists and marketers turn to measures of cross elasticity to help them reveal this relationship. Of interest is how marketing MSA can add to the application of cross elasticity in managerial economic MSA. We shall focus on: (1) the problem of gaps in the chain of substitutes, and (2) the impact of situational variables on cross elasticity.

Gaps in the Chain of Substitutes

MSA is plagued by "gaps in the chain of substitutes," which occur when products viewed as substitutes at one point in time are not at a later time due changes in objective and/or subjective determinants of product substitutability (early recognition of this is provided by Triffin [1940]. These gaps make the use of cross elasticity in deriving market definition highly problematic. As Needham argues:

Even if the information required to calculate precise measures were available, it is doubtful whether such information would be worth the effort involved in obtaining it. The relationships between commodities are not fixed but change over time with changes in consumers' tastes [emphasis added], productive techniques and the introduction of new products; therefore measures of the degree of substitutability between products, such as cross-elasticities of demand, may be expected to vary with the passage of "time" [Needham, 1978, 117].

Marketing MSA sheds light on the dynamic of cross elasticity, by investigating: the foundations of consumer preferences (i.e., consumer perceptions of product substitutability), changes in consumer preferences, and how these changes affect market boundaries. For example, a persuasive advertising campaign may explain the occurrence of gaps in the chain of substitutability and/or new chains of substitutability. Consider the potential impact of a recent advertising campaign aimed at convincing consumers that "orange juice is not just for breakfast" on inter-product competitiveness (and situational effects, as explained in the next section). Marketing MSA uses such strategic information to predict resulting market boundary shifts. Marketing MSA provides a methodology for filling in some of these gaps. The specificity of marketing MSA can be of value to economic analysis on such occasions..

Impact of Situational Variables

Marketing MSA may also contribute to the application of elasticity to market definition through its treatment of environmental factors that affect consumption satisfaction. Of interest here is person-in-situation (P-S) MSA [dating back to Belk, 1975]. The intent of P-S analysis is to incorporate situational effects along with consumer effects when consumer demand depends significantly on both. For example, restaurant patronage may depend on such situational factors as "atmosphere" and "type of clientele," as well as customer eating preferences.

Utilizing P-S analysis, Ball et al. [1992] segmented the Christchurch, New Zealand radio market on the basis of person-based (e.g., musical tastes) and situation-based characteristics (e.g., listening occasion)--that is, particular kinds of people in particular situations. They argued that their study "yielded actionable results from a managerial perspective" (1992: 408) for any radio station in the market striving to better position itself for increased market share.

P-S analysis may be of value to managerial economic MSA. It suggests that in some markets, situational variables significantly affect consumer perceptions of substitutability and thus product cross elasticity. In these markets, to the extent that relevant situational variables change, market boundaries may shift, aside from any changes in product-based and/or consumer-based characteristics.

Recall (from earlier discussion) that economists work with unspecified ceteris paribus conditions. As such, the ceteris paribus condition in economic MSA is conceptual; because of unknown potentially relevant variables which may affect market structure, precise specification is not possible [See Grunberg, 1966; Rappaport, 1995.]. Marketing P-S MSA, by identifying key situational variables that affect market structure, can provide additional (but never complete) specification of the explanans ("useful fiction") underlying the prototype market structures used in economic MSA.

Marketing P-S analysis may also be of value to managerial economic MSA regarding the application of product mix elasticities to firm strategic decision making. Relating elasticities to market structure is a difficult task. As Russell and Bolton argue, "Though the economic theory of demand is well elaborated..., the abstractness of the theory makes it difficult to forecast how a brand's marketing mix elasticities will be affected by changing competitive conditions" [1988: 229; also see Yadav, 1995]. For example, what will be the evolution of elasticities over the product life cycle? This has important implications for pricing policies (e.g., "skim" or "penetration"). P-S methodology can help reveal the relationship between market structure and elasticity structure. Returning to the radio market studied by Ball et al. [1992], one may discover that as radio listeners change their views of appropriate radio listening occasions, both market structure and elasticity structure will change. Consider, for example, the potential impact of miniature radio headphones (new technology) on radio listening occasion and thus market structure. Marketing P-S analysis is designed to analyze such developments and yield empirical, actionable results. This should be of value to managerial economic MSA as it grapples with the relationship between market structure and elasticity structure.

Summary and Conclusions

Marketing MSA relies upon three main avenues for deriving market structure--product-defined, purpose-defined, or a hybrid of the two. Its methodology is consistent with a variety of market structures for a particular market. Economic MSA, by design (reflecting its broad-based interests), is less complex, relying upon generic market structures to investigate a wide range of market behavior and generate fertile economic principles with respect to that behavior.

The methodological simplicity of economic MSA, however, can be misleading. Here, marketing MSA may be helpful. The methodology of marketing MSA provides insights into market structure not apparent in economic MSA, such as the underlying determinants of elasticity structures. Marketing MSA also sheds light on the elusiveness of market structure.

. Interestingly, marketing MSA is essentially the mirror image of--a methodological "looking glass" for--economic MSA. It incorporates much of the reality behind the "useful" fiction of economic MSA and thus may contribute to a better understanding of that fiction. Beyond that, it has applied relevance to economic MSA. For example, P-S MSA holds promise for filling in some of the gaps in the "chain of substitutes" caused by changes in elasticities over time. This has been problematic in economic MSA.

The relevance of marketing to economic MSA should not be surprising since economics is really the genesis of marketing, as a separate discipline. That marketing MSA has developed in ways that is relevant to economics can be viewed as the evolution coming full circle. This may be inevitable. As the boundaries of disciplines have narrowed over time, there often arise problems which can benefit from multi- or interdisciplinary analysis. It is in this respect that economic MSA can benefit from marketing MSA. Though not explored in this article, the converse is probably true. An important next step in this line of study is to develop an interdisciplinary MSA which would provide a useful synthesis of the tools and methodologies of economic and marketing MSA so as to better understand market structures. This article has set forth some of the foundation elements for such multi- or interdisciplinary MSA.

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