Market Power and Profit Maximization
Market power allows firms to increase economic profit through strategic tactics such as erecting barriers to entry, reducing rivalry, limiting substitutes, and reducing the power of buyers and suppliers (Brickley, Smith, & Zimmerman, 2009). Furthermore, market power is defined as “a company's ability to manipulate price by influencing an item's supply, demand or both. A company with market power would be able to affect price to its benefit. Firms with market power are said to be "price makers" as they are able to set the price for an item while maintaining market share” (Investopedia, 2013).
Essentially, companies must control all of the aspects of market power in order to be able to raise prices without losing customers. If a market is easy to enter (lack of entry barriers), then a price increase will allow another firm to erode profits by introducing a lower-cost product. Similarly, if rivalry is not reduced, each price increase will allow for a rival to keep prices the same and gain market share. In addition, substitutes at lower prices will hinder efforts to raise prices. Finally, if a company has few buyers, the buyers have the power. Therefore, price increases will be met with a potential loss of major profit centers.
In the NBC Video News Report: How to Raise Prices Without Losing Customers, Bob Prosen alludes to several practices that allow companies to raise customers without losing demand. Essentially, Prosen provides consultation on how to create inelastic demand, where a change in price does not result in a significant change of demand. For example, increasing the value proposition reduces the likelihood of substitute products (substitutes must copy increased value) and decreases rivalry (steps above rivals), resulting in the greater market power needed to raise prices.
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Prosen states that increasing value makes the customer appreciate the company more, resulting in the ability to raise price (Ramberg, 2012). As another example, Prosen stresses the importance of developing relationships, “people like to do business with people they like” (Ramberg, 2012). Essentially, Prosen is suggesting erecting barriers to entry by creating friendships and alliances, again resulting in increased market power needed to raise prices. As a capstone example of the need for market power, Research by
Mark McCabe of the Georgia Institute of Technology demonstrates the market power of academic journal vendors. Essentially, McCabe found that the consolidation of academic journal vendors (libraries) has led to an oligopoly, and therefore the price structure of academic journals is highly inelastic (McCabe, 2000). Because recent mergers had resulted in few suppliers, vendors of academic journals were able to control the market and raise prices through the use of supplier power. The demand for quality research for use in education cannot change; it is required.
Therefore, a change in price will not result in a drop in demand. References Brickley, J. A. , Smith, C. W. , & Zimmerman, J. L. (2009). Managerial Economics and Organizational Architecture. New York: The McGraw-Hill Companies, Inc. Investopedia. (2013, March 20). Market Power. Retrieved from Investopedia: http://www. investopedia. com/terms/m/market-power. asp McCabe, M. J. (2000). Academic Journal Pricing and Market Power:. THE AMERICAN ECONOMIC REVIEW, 259-269. JJ Ramberg (Author). MSNBC (Publisher). (07/20/2008). How to Raise Prices Without Losing
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