Assignment 2 - The Structure of the Global Market for Bicycles

In the environment of worldwide lockdowns, bicycle uptake surged due to gym closures and anxiety around public transport use. In 2020, the global market for bicycles accounted for USD 97.2B of sales, with a year-on-year growth rate of 48.6% (GrandView Research, 2021). Prior to last year, consumers took up cycling for many reasons, including as a method of commuting without traffic, and a growing consciousness for the environment and personal health. The subsequent analysis will focus on which structure fits the market for bicycles given competitive outcomes and whether the economic model explains results in the market.

Market Description

Before looking at specific characteristics of the market for bicycles,  it  is important to clarify some underlying elements. The bicycle market refers to the companies who design and manufacture bicycles, such as Giant and Trek. A local bicycle shop will be used as a distribution channel to sell their units at the  retail  price set  by  these  brands.  The  market  includes  all  subcategories  of bicycles,  including mountain, road, commuter, hybrid, and electric.

Characteristics of the Market

By analysing key characteristics for the global market for bicycles, the market structure logically fits the assumptions  of  monopolistic  competition,  notwithstanding  a  few  caveats.  The  assumptions  to  be evaluated include the number of firms, product differentiation, price, barriers to entry and profit.

First, let us consider the number of firms. The market has many sellers, with recent figures indicating around 150 bicycle brands in the US alone, and hundreds of others across the globe (Vosper, 2021). The growing demand for cycling  products  has  encouraged  more firms  into the  market, leading to intensified competition. These firms vary in size, with around 20-30 larger players, such as Giant and Specialized, and many smaller manufacturers like Parlee. However, what differentiates this market from an oligopoly is that there does not exist a few dominant firms who act strategically to earn a profit, with this market exhibiting a much higher degree of competition.

Next, we will look at the level of product differentiation. Bikes are generally differentiated by the intended use, such as mountain, road, or commuting. Within these subcategories, products are differentiated amongst brands through technology, performance, build quality and aesthetic . Premium brands use high-end  materials  and  manufacturing  techniques,  as  well  as  investing  more  into  research  and development to create innovative products. Ultimately, the consumers realise that there exists some non-price differentiating factors between competitors, meaning that products are not homogeneous. Consumers may perceive a higher risk in switching brands given products are not the same across the market.

The pricing outcomes within the bicycle market must also be analysed. A firm has full control over their price or production quantity and can adjust without competitors matching. For example, if Giant were to drop the price of their flagship model by $100, Specialised would not feel inclined to reduce their product’s price by the same margin. Whilst Giant may gain a small portion of customers from the lower price, Specialised and other brands will notice very minimal change to their sales. The loss of customers is spread across multiple firms given they all have relatively small market share. Therefore, different from an oligopoly, an individual bicycle manufacturer is a price maker.

By contrast, when considering barriers to entry, the  bicycle market does not  necessarily meet the assumptions of monopolistic competition . The barriers to entry are high given that a new firm would have to outlay large capital on developing a  product before manufacturing and distributing. Given consumers purchase on reputation and trust, it is difficult to break into this market without any brand equity. Moreover, large manufacturers enjoy huge economies of scale, with average total cost much lower for those who can exercise bargaining power. Nevertheless, there exists many firms in the market, with more entrants trying their hand due to recent cycling popularity.

In terms of profit, all firms are profit maximisers . As detailed in the next section, some firms do have a degree of monopolistic control over the price given their products remain differentiated, and certain brands hold strong brand equity amongst customers. Selling costs such as advertisement and public relations are high, and cyclists tend to be loyal to brands and particular componentry if it has served them well in the past. Therefore, some firms can charge a premium and generate a reasonable level of profit from this core target market as customers will remain even if price increases .

Market Outcomes using Model

Given that the market meets most of the monopolistically competitive assumptions, with exception of high barriers to entry, one can investigate various predictions of the model.

First, consider the demand curve. In monopolistic competition, if a firm decides to increase their price, it will lose some, but not all, of their customers as rival products are not identical. This is represented by a downward-sloping demand curve depicted by D1  in Figure 1. For example, manufacturer Canyon raised their prices by 20% in 2020, compared to Specialized who raised their prices by 12% (Bicycle Retailer, 2021). Given product differentiation, this action was not enough to divert all Canyon customers to other  relatively  cheaper  brands such as  Specialized,  as would  have  been  the  case  in  perfect competition.

Monopolistically competitive firms act like monopolists when setting price and output by choosing the profit-maximising  quantity  where  the  marginal  revenue  curve  (MR2)   intersects  the  marginal  cost curve (MC) , shown by point A. The respective price is where this quantity demanded intersects the demand curve, D , as shown by point C . Point B highlights where the output intersects the average total cost curve (ATC).

Figure 1: The Short-Run ‘Standard’ cost curves for Monopolistic Competition

The profit-maximising quantity the firm  is Qc , with a  price Pc  and the average cost to  produce this quantity of bicycles being PB . Firms enjoy a level of profit equal to the shaded area as price exceeds average cost at this quantity supplied.

Now, consider the entry of new firms in the long run after seeing the opportunity to make economic profit. The demand curve for an individual firm will shift to the left from D1  to D2  because of less bicycles being sold at any given price. This causes marginal revenue to shift left from MR1 to MR2 , and a new profit maximising price and output are established.

Figure 2: The Long-Run ‘Standard’ cost curves for Monopolistic Competition

The long run quantity supplied for the firm decreases to QF , with consumers paying a lower price PB   , which equals the average total cost to produce QF  units. Therefore, there is zero economic profit for a monopolistically competitive firm in the long run.

However, this result does not align with the reality of the bicycle market as some firms continue to make profit in the long run. For example, Giant Bicycles produced net income of $98.4M in the first half of 2020, with a gross margin of 21.7% (Bicycle Retailer, 2020) . This indicates that their demand curve lies well above the average total cost curve.

There are two ways a firm can stay in the profitable short-run outcome shown in Figure 1. Firstly, they can continuously innovate their product or develop new products, remaining ahead of the competition given that a factor of production is fixed and there is not enough time for new entrants to imitate. Sticking with the example of Giant, the company spends copiously on developing their products in wind tunnels to optimise aerodynamic efficiency. This ensures Giant stays one step ahead of the competition by distinguishing their product performance. In the long-run, other brands inevitably enter and mimic the actions of profit-making competitors, particularly when it comes to new technology and design, and the cycle repeats.

A firm can also look to produce an existing product at a decreased cost , temporarily shifting down the ATC curve. Economies of scale allows mass-production brands to offer a lower final price, and thus greater consumer value. Brands such as Reid offer entry-level riders a cheaper product through this strategy, as the average cost of production decreases with volume to a minimum. This minimum efficient scale for bicycle production is quite large given that the mark-ups are not highly lucrative. A paper by Professor Taylor Randall in 2001 suggested that the minimum efficient scale for bicycle manufacturing is  150,000 to 200,000 units annually (Randall, 2001). By comparison, Giant Bicycles produced 6.6 million bicycles in 2017 (Bicycle Retailer, 2017), indicating that the long-run average cost curve has a long flat minimum. The minimum efficient scale and long-run ATC  curve is depicted in Figure 3.

Figure 3: The Long-Run Average cost curves for the Market for Bicycles

Conclusion

The market for bicycles can be analysed and explained through the lens of our competitive market structure models. After analysing characteristics of this market, such as the high number of bicycle companies selling differentiated products, it fit the assumptions of monopolistic competition. Outcomes in the  market  also follow what the  monopolistically  competitive firms’  cost  curves  predict,  further validating the market structure and use of the economic model in the real world.

Bibliography

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