Types of competition

Classification of companies based on types of competition…..

Based on nature of competition they face, companies are classified under different segments.

  • Perfect monopoly
  • Oligopoly or duopoly
  • Monopolistic competition
  • Perfect competition

  • Perfect monopoly – As the name suggest, there is just one firm and can charge any price it wants. Obviously this is more in theory than practice, although we have had several monopolies in India till date. Overall monopolies are very profitable (if private) for the investor and bad for the consumer. Several examples come to mind – BSNL, MTNL, Indian airlines (in the past) and now Indian railways. These were (or could have been) extremely profitable (excluding railways) even after all the mismanagement and waste. In a nutshell a perfect monopoly or a close one is extremely profitable for an investor. I would also define a company a monopoly if it has a huge market share in its specific segment and can hold on to it due to some competitive advantage. THESE COMPANIES ENJOY DURABLE ECONOMIC MOAT
  • Oligopoly or duopoly – A limited number or just two firms in the market. Although not as profitable as a monopoly, I would say these companies are quite profitable and extremely good investments for the long run. Several companies come to mind in this group. For ex : Gillette and other shaving product companies.Crisil and other rating agencies, Asian paints and other paint companies.  One specific point worth noting is that the barrier to entry in this industry are high and hence new entrants cannot enter easily into the industry. As a result the incumbents can earn good profits.THESE COMPANIES ENJOY DURABLE ECONOMIC MOAT
  • Monopolistic competition – A large number of companies with limited profitability. Barriers to entry are not too high and as a result new companies can enter the industry more easily. I would say most of the commodity companies fall under this group. For ex: cement, steel, Auto, Telecom,Banks,Housing finance companies etc. Few companies in this kind of industry enjoy high profits and generally the lowest cost provider has some kind of competitive advantage. As an investor I would look at companies which have some kind of low cost advantage, some other local or national competitive advantage and a good management. Bad management in such an industry can kill the company.

  • Perfect competition A ideal or theoretical construct more than a practical scenario. In such an industry there is no competitive advantage at all, all companies are price takers and they earn only the cost of capital. I would say very few industries would fall in this group. Brokerage firms come close to perfect competition, but still this is more theory than reality.

The way to classify an industry in any one of the above groups is to look at the following variables
– Number of companies in the industry controlling 60-70% of the sales in the industry
– Average profitability of the companies
– Change in relative Market share between companies over a period of time

By doing the above analysis, one can figure out the level of competition and as a result have a rough idea of the long term economics of the industry. It also gives fair idea to identify companies having moats which are either widening or diminishing.

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