lecture 6 sustaining technology lets skilled early ...simonk/pdf/igc_lec6.pdf · 4 8 12 millions...
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EC2212 Industrial Growthand Competition
Lecture 6
Sustaining technology lets skilledearly entrants destroy competitors.
Shakeouts• New products: often rise then fall in number of
producers
• Fall in number of producers often called a“shakeout”
• Most products have shakeouts, within 3+ decadesof when the market forms
• Can be very dramatic: US automobiles went from273 producers to 5
• Concentrated market shares tend to result
1894 1912 1930 1948 1966
0
55
110
165
220
275firms
exit
entry
US Automobile Producers, 1896-1966
Why Do Shakeouts Happen?
• Focus on the main cause
• … in products with severe shakeouts
• You will see– Evidence on entry and exit
– Theory that best fits the facts• approximately, Klepper (1996, 2001)
– Evidence on early-movers, technology
• Then discuss ramifications
1894 1912 1930 1948 1966
0
55
110
165
220
275
0%
32%
Automobiles
firms
exit
entry
%exit
5-yearmovingaverage
1905 1920 1935 1950 1965 1980
0
55
110
165
220
275
0%
25%
Tires
firms
exit
entry
%exit
5-yearmovingaverage
1945 1956 1967 1978 19890
22
44
66
88
110
0%
24%
Televisions
firms
exit
entry
%exit
5-yearmovingaverage
1942 1952 1962 1972 1982 1992
0
6
12
18
24
30
0%
29%
Penicillin
firms
exit
entry
%exit
5-yearmovingaverage
Firms, Entry, Exit in Four Products (US)
1945 1952 1959 1966 1973 1980
$0
$400
$800
$1,200
0
4
8
12
millionsB&W
priceproduced
Televisions
$0
$400
$800
$1,200
0
4
8
12millionsColor
priceproduced
0
2
4
6
1945 1955 1965 1975
0
4
8
12Penicillin
price (10 $/ lb.)3 prod’n (10 lbs.)6
$1,500
$3,000
$4,500
$0
1900 1910 1920 1930 1940
0
1.5
3
4.5Automobiles
price millionssold
0
100
200
300
1910 1919 1928 1937
0
20
40
60
80
price
millions
Tires
sold
index
Price and Output in the Four Products
Explanation of Shakeouts
Part 1 of 3
Entrants and Their Skills
More Skilled Firms Can Earn More Profit
low highcompetence at R&D
% ofpotentialentrants
Potent ial Ent rants in Year X
Shaded region: firmshave enough skill to earnprofi t > 0 after ent ry
Entry & Growth Drive Down Price
• Limited number of firms have skills neededto enter, at any point in time
• Each year some number of firms can enter
• Firms enter fairly small, but then grow
• Entry and growth increase total output
• More output, lower price (demand curve)
Skill Needed to Enter Rises over Time
low highcompetence at R&D
% ofpotentialentrants
Potent ial Ent rants in Year X
Shaded region: firmshave enough skill to earnprofi t > 0 after ent ry
With lower price, needmore skill to earn a profit
Entry Eventually Stops
low highskill
lowskill
high low highskill
%
Entrants need increasing skill to earn profit > 0, since price falls
Time 1 2 3
EXAMPLE:60 potential firms40 enter
300 potential firms70 enter
800 potential firms0 enter
May be more potential entrants, but eventually no entrants
Explanation of Shakeouts
Part 2 of 3
R&D, Size, and Profit
R&D with Imitation
• R&D improves quality, lowers cost
• Decreasing returns to R&D
• Cost-per-unit-of quality c = c(R), c'<0,c''>0
• Firms benefit from R&D during 1 timeperiod
• Firms imitate all past innovations in thenext period
Firm i’s Profit at Time t
• pt price per unit of quality, pt = ƒ(∑Qit)
• [ct – sic(Rit)] cost per unit produced– ct highest possible cost given imitation of past R&D
– si firm i’s skill at R&D
– c(Rit) cost decreases with current R&D, c'<0, c''>0
• Qit output produced
• Rit spending on R&D
• g(Qit – Qit-1) cost of growth, g'>0, g''>0
Π it t t i it it it it itp c s c R Q R g Q Q= − −[ ]( ) − − − −( ) ( )1
Implications of the Profit Function
• Firms choose Rit, Qit to maximize profit
• Larger firms spend more on R&D– Spread cost of R&D over more output
– Remember lecture 3
• Growth is limited– Firms grow each period
– Increasing marginal cost limits growth
• Size (Qit) and skill (si) enhance profit
Explanation of Shakeouts
Part 3 of 3
Exit (given Size and Skill)
Who Exits When?
• Firms exit if Πit < 0
• Growth causes exit at every t– Growth → ΣQit → pt → profit
• Exiting firms are smallest, least-skilled– Since size and skill enhance profit
• Earlier entrants are larger, ceteris paribus– Have had more time and incentive to grow
• Skilled early entrants are long-run survivors
Summary in Course Notes, p. 89
low highcompetence of managers
% ofpotentialent rants
incompetent :higher costs
competent:lower costs
(Potent ial) Ent rants 1895-1904
low highcompetence of managers
% ofpotent ialentrants
(Potential) Entr ants 1905-1909
low highcompetence of managers
% ofpotent ialentrants
(Potential) Entrants 1910-1916
(By mid-1920s,entr y becomesimpossible.)
How big are f irms that entered in 1895-1904? How big... entered in 1905-1909? How big... entered in 1910-1916?
circa 1904
circa 1909
circa 1916
small
medium (but 80% have exited)
large (but 90% have exited)
small
medium (but 80% have exited) small
Firms always enter at small sizes.As t ime goes on, surviving f irms grow.At any point in t ime, earlier ent rants are larger t han later ent rants.
Size and competence reduce a f irm's costs. Because ofsurvival of the f itt est, f irms in each group are forcedout unt il only competent early ent rants remain.
Implications of the Theory
• Shakeout– Entry eventually stops
– Exit continues forever, causing shakeout
• Earlier entrants have lower chance of exit– Maybe not at first (depends on skill distribution)
– But eventually even high-skilled late entrants exit
• Earlier entrants do more R&D
• Firms successful at R&D survive better
% Survival by Entry Date of Automobile Producers
0 14 28 42 56 70
100%
0.1%
Years of Production
Firms Surviving
Entrants in 1895-1904
1905-09
1910-66
31.6%
10.0%
3.2%
1.0%
0.3%
S 1S 2
0 14 28 42 56 70
100%
0.1%
Automobiles
Years of Production
Firms Surviving
Entrants in 1895-1904
1905-09
1910-66
31.6%
10.0%
3.2%
1.0%
0.3%
S1S2
0 20 40 60 80
100%
31.6%
10.0%
3.2%
1.0%
Tires
Years of Production
Firms Surviving
Entrants in 1901-1906
1907-16
1917-22
1923+
S1
S2
S3
0 9 18 27 36 45
100%
31.6%
10.0%
3.2%
1.0%
Televisions
Years of Production
Firms Surviving
Entrants in 1946-1948
1949-1951
1952+
S2
S1
0 10 20 30 40 50
100%
31.6%
10.0%
3.2%
1.0%
Penicillin
Years of Production
Firms Surviving
Entrants in 1943
1945-52
1953+
S1
S2
% Survival by Entry Date in the Four Products
0 7 1 4 2 1 2 8 3 5
1 0 0 %
3 1 . 6 %
1 0 . 0 %
3 . 2 %
1 . 0 %
Pens, Ballpoint
% Survival by Entry Date in a Non-Shakeout Product
Entrants 1946-50
1951-54
1955-67
1968-79
Years of production
Innovation, % Adoption, by Entry Time in the Four Products
Use same entry-time cohorts as previously, but divide tires cohort 1
Product Innovation type Cohort 1 Cohort 2 Cohort 3Automobiles Product 9 2 1Automobiles Process 3 0 0.1Tires Product 1 0 0Tires Cord 1917 36% 8%Tires Cord 1920 100% 73% 62%Tires Balloon 1923 63% 16% 7%Televisions Product 2 1 0Televisions Process 63 7 0Penicillin Process 5 0 0
Relative innovation rates by product & innovation type — compare cohorts
0
.28
.21
.14
.07
Aut omobi les
1895 1967194919311913
Smoot hed Hazard
Non-Innovat ors
Innovato rs
Innovation and Exit
0
.28
.21
.14
.07
Aut omob i les
1895 1967194919311913
Smoot hed Hazard
Non-Innovat ors
Innovat ors
0
.24
T i r e s
1920 1980
Smoothed Hazard
Non-Innovat ors
Cord &Balloon Tires
Cord Tires
.06
.12
.18
196519501935
0
.24
1952 1980
Smoot hed Hazard
Non-Innovat ors
Te lev is ions
Innovato rs
1966 19731959
0
.36
.18
.27
.09
Pe n i c i l l i n
1959 1992
Smoot hed Hazard
Non-Innovat ors
1983.751975.51967.25
Semisynt hetic Producers
Innovation and Exit in the Four Products
Ramifications of Shakeouts
• In industries with strong sustaining R&D
• High-skilled early entrants dominate
• Other firms may profit for a while– But eventually forced to exit
• Enter early, keep up with R&D, to survive
• Concentration is a natural result– Anti-trust authorities often investifate
– But expect concentration with legal behavior