Cost Structures in Business
The cost structure of a firm refers to the different expenses the business incurs as a result or in the course of its daily operations. Typically, the cost covers both the fixed and variable costs, where fixed costs are those expenses that remain unchanged irrespective of the level of production while variable costs change depending on the production volume. Many factors, both within and without a firm, affect the cost structure of a firm. Even within the same corporation, cost structure may vary between different lines of products or business units depending on the performance of each.
To understand why the cost structure associated with many kinds of information goods and services might imply a market supplied by a small number of large firms, one first needs to comprehend how the oligopolies are structured and how prices in such markets are affected. In oligopolies, prices change much less frequently than they do under other market models like monopolistic competition and monopoly. The result, quite often, is that when the prices change, most of the firms in the market choose to move in the same direction, and often by same margins as a result of collusion (Samuelson & Marks, 2012). In the information goods and services market, cost structure displays similar trends as that of an oligopoly. Moreover, the reaction of firms to changes in price by their competitors reflects the same awareness. If one competitor lowers their prices, other companies follow suit. If they hike them, the others are most likely to retain their prices in an effort to curve off their market.
Lower transaction costs improve the ability of small suppliers to compete. Samuelson & Marks (2012) cite a wide-ranging research study by Washington’s Brookings Institution which estimated that “across the whole of the U.S. economy, the adoption of information technology and e-commerce methods was producing total annual cost savings of a magnitude equivalent to about 1 percent of the annual gross domestic product.” Increased efficiency stemmed from a re-engineering of the firm’s supply chain and a reduction of transactions costs of all kinds. Further, the research found that the greatest potential savings emerged in information-intensive industries like health care, education, financial services, and the public sector. What the research demonstrates is that while there are numerous benefits to e-Commerce business, one of the greatest is that it reduces transaction costs. Since these have great bearing on the firm’s ability to keep its production costs low, and thus turn a profit, lower transaction costs in e-commerce can, in fact, make it easier for small suppliers to compete.
Finally, network externalities can affect a firm’s operating strategies. According to Samuelson & Marks (2012), network externalities confer market power to organizations. How? The firms with the largest user base or network can claim increasing market share. As a result, such firms can command premium prices for their goods and services. The resultant effect is that such firms can attain a significant average-cost advantage over smaller rivals. As such, they are in a venerable position. When combined together with economies of scale, network externalities ensure that such firms are also shielded from price competition. Consequently, market leaders in any category are afforded positive economic profits that other players in the same segment have no access to.
Samuelson, W., & Marks, S. G. (2012). Managerial Economics (7th ed). Hoboken, N.J: Wiley.
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