Market Efficiency 305initiatives or in any other areas—as a way to gain a competitive advantage
over its rivals. However, if all (or most) firms in a given market successfully
exploit e-business methods to lower unit costs, the upshot is that the entire
industry supply curve shifts downward. In a perfectly competitive market,
these cost reductions are passed on, dollar for dollar, in lower prices to con-
sumers. In the long run, only the most efficient firms will serve the market
and economic profits again converge to zero.
Fourth, by lowering barriers to entry, online commerce moves markets
closer to the perfectly competitive ideal. The e-business environment fre-
quently means a reduced need for capital expenditures on plant, equipment,
and inventories as well as for spending on highly trained direct sales forces.
Elimination or reduction of these fixed costs makes it easier for numerous (per-
haps small) firms to enter the market and compete evenhandedly with current
competitors.
What aspects of the online business environment are at odds with perfect
competition? First, numerous e-business goods and services are highly dif-
ferentiated. (They do not fit the standardized designation of perfect com-
petition.) Differentiation allows the firm to raise price without immediately
losing all sales. (Its demand curve is downward sloping, not horizontal.) For
example, the firm can potentially command higher prices for ease of use,
better customer service and support, faster shipping, and customized offers
and services. Even in cyberspace, a firm’s ability to earn positive economic
profits depends on how well it differentiates its product and how effectively
it establishes a strong brand name. Thus, a loyal customer of Amazon.com
will continue to shop there for the ease, convenience, and product selection,
even if prices are somewhat higher than at other sites. (Moreover, informa-
tion goods usually exhibit high switching costs: Consumers are reluctant to
learn to use a new software system or to navigate through an unfamiliar Web
site.) Second, network externalities and economies of scale confer market
power. The firm with the largest user network (e.g., Google in search,
Microsoft in PC operating systems, eBay in online auctions, America Online
in instant messaging, Oracle in database software) will claim increasing mar-
ket share and be able to command premium prices. In addition, the pres-
ence of economies of scale (due to high fixed costs and low marginal costs)
means that market leaders (such as Google and Apple’s itunes) will command
a significant average-cost advantage relative to smaller rivals. All of these fac-
tors create barriers to entry, preventing new rivals from penetrating the mar-
ket. Thus, shielded from price competition, the market leaders are able to
earn positive economic profits.
Although e-business offers obvious avenues for increased competition, it
does not eliminate the potential for claiming and exploiting market power in
a number of traditional ways. As management expert Michael Porter puts it,
“Because the Internet tends to weaken industry profitability, it is more impor-
tant than ever for companies to distinguish themselves through strategy.”c07PerfectCompetition.qxd 9/29/11 1:30 PM Page 305