Competition - Economics and Business

Economics and Business

Merriam-Webster defines competition in business as "the effort of two or more parties acting independently to secure the business of a third party by offering the most favorable terms". It was described by Adam Smith in The Wealth of Nations (1776) and later economists as allocating productive resources to their most highly-valued uses. and encouraging efficiency. Later microeconomic theory distinguished between perfect competition and imperfect competition, concluding that no system of resource allocation is more efficient than perfect competition. Competition, according to the theory, causes commercial firms to develop new products, services and technologies, which would give consumers greater selection and better products. The greater selection typically causes lower prices for the products, compared to what the price would be if there was no competition (monopoly) or little competition (oligopoly).

However, competition may also lead to wasted (duplicated) effort and to increased costs (and prices) in some circumstances. For example, the intense competition for the small number of top jobs in music and movie acting leads many aspiring musicians and actors to make substantial investments in training which are not recouped, because only a fraction become successful. Critics have also argued that competition can be destabilizing, particularly competition between certain financial institutions.

Experts have also questioned the constructiveness of competition in profitability. It has been argued that competition-oriented objectives are counterproductive to raising revenues and profitability because they limit the options of strategies for firms as well as their ability to offer innovative responses to changes in the market. In addition, the strong desire to defeat rival firms with competitive prices has the strong possibility of causing price wars.

Three levels of economic competition have been classified:

  • The most narrow form is direct competition (also called category competition or brand competition), where products which perform the same function compete against each other. For example, one brand of pick-up trucks competes with several other brands of pick-up trucks. Sometimes, two companies are rivals and one adds new products to their line, which leads to the other company distributing the same new things, and in this manner they compete.
  • The next form is substitute or indirect competition, where products which are close substitutes for one another compete. For example, butter competes with margarine, mayonnaise and other various sauces and spreads.
  • The broadest form of competition is typically called budget competition. Included in this category is anything on which the consumer might want to spend their available money. For example, a family which has $20,000 available may choose to spend it on many different items, which can all be seen as competing with each other for the family's expenditure. This form of competition is also sometimes described as a competition of "share of wallet".

In addition, companies also compete for financing on the capital markets (equity or debt) in order to generate the necessary cash for their operations. An investor typically will consider alternative investment opportunities given his risk profile and not only look at companies just competing on product (direct competitors). Enlarging the investment universe to include indirect competitors leads to a broader peer universe of comparable, indirectly competing companies.

Competition does not necessarily have to be between companies. For example, business writers sometimes refer to internal competition. This is competition within companies. The idea was first introduced by Alfred Sloan at General Motors in the 1920s. Sloan deliberately created areas of overlap between divisions of the company so that each division would be competing with the other divisions. For example, the Chevy division would compete with the Pontiac division for some market segments. The competing brands by the same company allowed partes tobe designed by one division and shared by several divisions, for example parts designed by Chevy would also be used by pontiac. Also, in 1931, Procter & Gamble initiated a deliberate system of internal brand-versus-brand rivalry. The company was organized around different brands, with each brand allocated resources, including a dedicated group of employees willing to champion the brand. Each brand manager was given responsibility for the success or failure of the brand, and compensated accordingly. This is known as intra-brand competition.

Finally, most businesses also encourage competition between individual employees. An example of this is a contest between sales representatives. The sales representative with the highest sales (or the best improvement in sales) over a period of time would gain benefits from the employer.

Shalev and Asbjornsen also found that success (i.e. the saving resulted) of reverse auctions correlated most closely with competition. The literature widely supported the importance of competition as the primary driver of reverse auctions success. Their findings appear to support that argument, as competition correlated strongly with the reverse auction success, as well as with the number of bidders.

It should also be noted that business and economic competition in most countries is often limited or restricted. Competition often is subject to legal restrictions. For example, competition may be legally prohibited, as in the case with a government monopoly or a government-granted monopoly. Tariffs, subsidies or other protectionist measures may also be instituted by government in order to prevent or reduce competition. Depending on the respective economic policy, pure competition is to a greater or lesser extent regulated by competition policy and competition law. Another component of these activities is the discovery process, with instances of higher government regulations typically leading to less competitive businesses being launched.

Competition between countries is quite subtle to detect, but is quite evident in the world economy. Countries compete to provide the best possible business environment for multinational corporations. Such competition is evident by the policies undertaken by these countries to educate the future workforce. For example, East Asian economies such as Singapore, Japan and South Korea tend to emphasize education by allocating a large portion of the budget to this sector, and by implementing programmes such as gifted education.

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