THE COMPETITIVE NEIGHBORHOOD

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Dominic Newton
5 years ago
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1 s 11 A firm does not compete against all other firms in the economy. Rather, a firm competes with those firms within the firm s competitive neighborhood. The extent of competition the virulence of competition a firm faces can vary tremendously in different competitive neighborhoods. THE COMPETITIVE NEIGHBORHOOD One component of a firm s competitive neighborhood is a subset of competitors in the same industry of the firm. An industry is a collection of business firms selling goods and services that are similar but not necessarily identical to each other. Such product are, not surprisingly, generally fairly good substitutes for one another. Table 1 presents information about 22 of the over 1,200 industries found in North America. These industries are those defined in the North American Industry Classification System (NAICS).

2 122 s NAICS Code Industry Name Table 1 22 Selected Industries in the United States Hog and Pig Farming Sheep Farming Farm Management Services Support Activities for Animal Production Wineries Soft Drink Manufacturers Commercial Lithographic Printing Blankbook, Looseleaf Binders, and Devices Manufacturing Tire Manufacturing (except Retreading) Alumina Refining Pen and Mechanical Pencil Manufacturing Sporting and Recreational Goods and Supplies Merchant Wholesalers Recreational Vehicle Dealers Sewing, Needlework, and Piece Goods Stores News Dealers and Newsstands Air Traffic Control Web Search Portals Libraries and Archives Document Preparation Services Septic Tank and Related Services Outpatient Mental Health and Substance Abuse Centers Car Washes Space Research and Technology All firms in all these industries do not compete against each other. Rather, firms selling similar products compete against each other. For instance, one car wash (in NAICS industry ) faces competition from other car washes: although not all car washes are the same, they all sell quite similar products. But it is also true that any given car wash does not compete against all other car washes in the United States. A given car wash in Fresno might compete against other car washes within, say, a 10-mile radius. It might not compete with car washes located outside this 10-mile radius. The competitive neighborhood of a firm, then, does not necessarily include all other competitors within the firm s industry. Any given car wash does not

3 s 123 complete against all the 13,500 car washes within the United States. Rather, the competitive neighborhood of a given car wash might include only, say, the 9 other car washes within the local area. In other situations, a firm might compete with a large majority of the other competitors operating in the same industry. For instance, in the Soft Drink Manufacturing industry (NAICS industry ) the firm Coke-Cola, which sells throughout the United States, might has as competitors all other firms in the Soft Drink Manufacturing industry. Some firms are purely local sellers while other sellers are national indeed international sellers. The competitive neighborhood of a given firm in one industry might also include competitors from other (narrowly defined) industries. For instance, Coke-Cola in its role as a seller of soft drink products competes not only with other firms within the Soft Drink Industry (such as PepsiCo, Cadbury Schweppes (owner of Dr. Pepper and 7-Up), and IBC), it also competes with firms that sell bottled ice tea, orange juice, bottled water, and energy drinks (such as Red Bull). These other firms are not in the same industry Soft Drinks but they are in the competitive neighborhood of Coke-Cola. The firms that Coke-Cola competes with include both those that sell relatively close substitutes (those in the same industry) and those firms that sell more distant substitutes such as bottled water. Coke-Cola does not compete, however, with firms that sell hammers. Coke and hammers are not substitutes at all. Figure 1 presents a diagram of Coke s competitive neighborhood in its role as a seller of soft drinks. Some firms are within the industry (and within the competitive neighborhood), other firms are outside the industry (but within the competitive neighborhood, and still other firms (in other industries) are completely outside Coke s competitive neighborhood.

4 124 s Figure 1 Coke s Competitors in the Same Industry Arrowhead water 7- Outside of the Pepsi COKE Dr. Pepper Snapple Hire s Root Red Bull Adhesives, Advertising Air Compressors... A firm s competitive neighborhood includes all other firms with which the firm competes. All these competitive firms sell products that are possible substitutes for significant numbers of potential customers. THE NUMBER OF FIRMS AND THE EXTENT OF COMPETITION One main determinant of the extent of competition faced by a firm is the number of firms within its competitive neighborhood. A firm that finds 200 firms within its competitive neighborhood will typically face more competitive pressure than a firm that finds only 10 other firms in its competitive neighborhood. Figure 2 illustrates a situation in which a firm, here named Bill s pencils, that faces 200 firms in its competitive neighborhood. This is a relatively high level of competition.

5 s 125 Figure 2 Many Firms within the Competitors in the Same Industry of firms = 75 Bill s Total Competitors = = 200 of firms = 125 Figure 3 illustrates a competitive neighborhood for a firm, Rapid Car Wash, which has much less competition. Only 10 firms exist in the competitive neighborhood of Rapid Car Wash. Figure 3 Only a Few Firms within the Competitors in the Same Industry of Total Competitors = = 10 firms = 4 Rapid Car firms = 6 of

6 126 s Firms that face more firms in their competitive neighborhood generally face a greater level of competition that do firms that have fewer firms in their competitive neighborhoods. Everything else remaining equal, firms like to see the number of firms in their competitive neighborhood decline. Although an increase in the number of firms in the competitive neighborhood increases the extent of competition faced by a firm, an increase in the number of firms within the industry (rather that outside the industry but within the competitive neighborhood) generally leads to more competition than an increase non-industry members of the competitive neighborhood. This is simply because firms in the same industry sell a product that is more like the firm in question than firms outside the industry.

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