1

THE STRUCTURE-CONDUCT-PERFORMANCE PARADIGM:

EXPLAINING, MEASUREMENT AND TESTING THE THEORY

CONTENT
1.

Introduction

2.

SPC-paradigm: The explanation

3.

Measuring the Structure Conduct Performance-

paradigm
4.

Variables of the Structure Conduct Performance-

paradigm
4.1

Market structure

4.1.1 Buyer and seller concentration

4.1.2 Product substitution
4.1.3 Entry conditions
4.2

Market conduct

4.2.1 Pricing strategies

4.2.2 Mergers
4.2.3 Collusive Behaviour
4.3

Market Performance

4.3.1 Profitability
4.3.2 Efficiency
5.

Testing the Structure Conduct Performance-paradigm

6.

Conclusion

THE STRUCTURE-CONDUCT-PERFORMANCE PARADIGM:

EXPLAINING, MEASUREMENT AND TESTING THE THEORY
1.

Introduction
The purpose of the essay is to look at efforts to measure the
Structure Conduct-Performance-paradigm, the explanation of
the paradigm, efforts to test the paradigm and the relationship
between the variables. It provides an overview between the
relationship between profits and the concentration (number of
firms needed to produce a certain level of output).

2.

The SCP-paradigm: The explanation

The Structure Conduct Performance approach indicates that
market performance is determined by market conduct, which in
turn depends on market structure. The structure, conduct and
performance
characteristics

are

interconnected

against

models

of

through
perfect

structural
competition,

monopolistic competition, oligopoly and monopoly. The table

below draws the linkage between the structural characteristics
and

the

models

of

perfect

competition,

monopolistic

competition, oligopoly and monopoly.

Structure

Conduct

Performan

Structural
Characteristics
Number of firms

Market 1

Market 2

Many firms with small Four firms with similar

market share

market share

Number of buyers

Many

Few

Nature of product

Homogeneous

Differentiated

Entry barriers
Low
Substantial
Source: Ferguson & Ferguson: (1996) Pages 15-16
The table shows that in market 1 the characteristics of a perfect
competition structure. Market conduct can be derived from the
structure meaning that in the case of a large number of firms
usually leads to industry competitors to determine their own
prices and levels of output. From a performance side it will
mean that prices tend towards equalising marginal cost
(P=MC), thus normal profits in the long run. Performance in
particular markets can also be influenced through structure,
because structural conditions provides sufficient information for
performance to be predicted.
The situation in market 2 differs from market 1 in the sense that
a small number of firms determine the price and level of output.
This usually leads to higher prices and lower levels of output.
The firms behaviour (conduct) such as pricing, advertising etc.
are collusively determined by the small number of firms.
However, market structure does not necessarily means collusive
behaviour. In an effort to keep acceptable levels of economic
performance, oligopolists will compete for market share in an
effort to keep price close to perfect competition (P=MC).

3.

Measuring

the

Structure

Conduct

Performance-

paradigm
The traditional way of measuring the market structure is by
making use of measures of market concentration, which focuses
on the number and size distribution of firms. The fewer the
number of firms and/or the more disparate their size, the more
concentrated the market. (Ferguson & Ferguson: 39) Market
concentration gives an indication of the degree of market power,
which is revealed, by the margin between price and marginal
cost. Price-cost margins are positively related to the HerfindahlHirschman index.
Alternative

measures

of

market

concentration

can

be

summarised as follows:
A concentration curve can be constructed from firms ranked
in size order from the largest to the smallest and plotted
against

their

cumulative

output.

Measures

of

market

concentration seek to transform the number and size

distribution depicted by these firms into a single value.
Absolute measures combine the number of firms and their
size disparities of which the following are examples:
Concentration ratio- measures the cumulative market
share of the largest number of firms.
x

CR x S i
i 1

where S denotes market share.

A value close to zero indicates that the largest number of
firms supplies a small portion of the market share. A
single supplier will supply 100% of the market share, thus
monopolistic behaviour.

Herfindahl-Hirschman index- calculates the output of the

firm divided by the total output. This means the summing
of the squares of market share of all the firms in the
market.
n

HHI S i2
i 1

where n denotes number of firms.

An index close to zero means there are a large number of
equal sized firms, and a value of one means monopoly.

Hannah and Kay index- is basically the same as the

Herfindahl-Hirschman index except that market share is
raised to the power which denotes any number of firms.

HK

S
i 1

1 /(1 )

A value between the range of 0.6 to 2.5 is suggested to

provide the most reliable results.
Entropy index- indicates the market share weighted by the
logarithm of the market share.
n

E S i log(1 / S i )
i 1

A value of zero suggests that there is only one firm in the

market. The maximum value in the case of firms with
equal market share is the log value of the number of firms
in the market.
The

80

percent

Occupancy

Count-

measures

the

concentration number of the firms constituting 80% of

industry output.

The C5% - measures the cumulative market share of the

top 5% of firms in an industry. In the case of South Africa,
it provided a high degree of seller concentration.
Relative measures concentrates on the disparities in size of
firms operating in a particular market. The following two
measures serves as examples:
Variance of the logarithms of firm size- measures the
difference between the logarithms of the firms in the
market.
V

1
N

(log S i ) 2
i 1

1 n
( log S i ) 2
N 2 i 1

If the value is zero, all firms are equal in size.

Gini-coefficient measures the size of firms ranked from
the smallest to the largest as a percentage of the number
of firms in the market, plotted against the cumulative
output of these firms. The greater the deviation from the
diagonal line, the greater the inequality in firm size.
Fourie and Smit also used the Gini-coefficient to measure
the impact of import competition on concentration.
The

summary

measure:

The

Rosenbluth

index

gives

considerable weight to the number of firms in an industry,

thus relative more small firms.

R 1 (1 Gini )
n
In using the Rosenbluth measurement, Leach concluded that
an opposite trend is shown compared to the other measures.

4.

The variables of the Structure Conduct Performanceparadigm

4.1

Market structure
Bain defines market structure as those characteristics within a
market that influence the nature of competition and pricing in
the market. The characteristics can be distinguished in terms of
concentration (number of firms) of which perfect competition
and imperfect competition are the significant components. In
order to measure the significance of market structure within the
paradigm; the market structure was viewed from the following
dimensions:

4.1.1 Buyer and seller concentration

Buyer and seller concentration measures proxies for market
power in terms of input (capital and labour) and output (sales)
possessed by the most significant firms according to size.
Market concentration can be expressed as a ratio of the number

of firms (n) of total sales

S
i

. From the perspective of

competitive power, it could be argued that seller concentration

does not necessarily reflect the true nature of competitiveness.
In cases where firms are locked in restrictive trade agreements,
been price leaders or through government legislation with
regard to prices and wages, the true nature of competition is
disguised.
According to Galbraith, countervailing power should also be
considered. He based his argument on the fact that monopolists
and

oligopolists

(sellers)

might

sell

to

monopsonist

and

oligopsonists (buyers), because the buyers could amalgamate in

an effort to avoid exploitation and simultaneously share in

monopoly profits.
4.1.2 Product substitution
A firms ability to differentiate products plays an essential role
in

market

concentration.

It

will

decrease

or

eliminate

substitution for similar products competing in the market.

Differentiation creates a situation where market structure
departs

from

perfect

competition,

because

it

creates

downward sloping demand curve for those products. This means

that as the price of a good increases the desire to consume the
good decreases. However, should producers enforce product
differentiation in order to decrease the degree of product
substitutability and the number of producers are reduced,
monopolistic or oligopolistic conditions would occur.
4.1.3 Entry conditions
Entry conditions define the relationship between existing firms
and possible entrants in the market. The impact of new entrants
will rely on assumptions based on (a) business goals; (b) cost
advantages of existing firms; and (c) price vs. output behaviour
of existing firms. The degree of difficulty in entering a market
depends on product differentiating as well as advantages with
regard to costs and economies of scale. Bain suggested that
superior production technique; superior resources etc. also
plays a vital role in market entry. Demsetz argued that there are
other reasons for profit maximisation than collusion, which are
therefor strengthened by Bains suggestion.
4.2

Market Conduct

10

Market conduct can be defined as patterns of behaviour by

enterprises in an effort to adjust to the markets in which they
operate (buy or sell). Pricing strategies, collusive behaviour
mergers etc. is few dimensions of market conduct.
4.2.1 Pricing strategies
The behaviour of firms in setting their prices also play a vital
role

in

the

SCP-

paradigm.

Price

strategies

like

price

discrimination, predatory pricing, price fixing are only a few

examples.
Price discrimination refers to a situation where firms are selling
the same product at different prices to different customers.
Price fixing on the other hand refers to a situation where market
structure does not allow sellers to sell products at prices below
listed prices of manufacturers. The predatory pricing on the
other hand allow products to be sold at prices below production
costs (marginal cost or average cost). The main purpose of these
strategies is to acquire market share, thus monopolistic profits.
4.2.2 Mergers
Market conduct, of which market power results, can also be
viewed as a way in which the firms behave in order to increase
market share. Three different types of mergers can be identified
namely, horizontal mergers, vertical mergers and conglomerate
mergers. Horizontal mergers occur when firms in the same
industry combine. Vertical mergers occur when firms combine
at different stages of the production process. Conglomerate
mergers on the other hand combine unrelated firms.
4.2.3 Collusive Behaviour

11

Imperfect competition in the market does not always depend on

the size of firms, but also on the behaviour of firms. In a market
with few competitors firms can decide whether to be non-cooperative or co-operative. In order to minimise competition
amongst them; firms tend to co-operate engaging in collusion.
This creates a situation where firms jointly set prices and
outputs

as

well

as

sharing

the

market

amongst

them.

Cartelisation is another form of collusive behaviour. It comprises

of a set of independent firms that produces similar products
working together to raise prices and restricts output.
4.3

Market performance
Market performance can be defined as the outcome or
comprises of end results of firms in the market due to market
structure and market conduct. Profitability, efficiency, etc. are
only a few dimensions from which market performance can be
measured. However, in measuring market performance a few
difficulties might arise due to the lack of uniformity in the use of
concepts such as market, firm and profit. The inconsistency in
data and the introduction of restrictive government legislation
increases

the

degree

of

difficulty

to

measure

market

performance.
4.3.1 Profitability
Profitability measures the rate of return on capital, thus a key
indicator of market power. Vigorous competition amongst firms
for market power might lead to imperfect competition because
of incentives to become highly concentrated in an effort to gain
monopolistic profits. High rates of return on capital in the
market

place

usually

reflect

market,

which

is

in

12

disequilibrium. Brozen also supports this argument, because he

viewed

the

market

structure

in

such

conditions

to

be

monopolistic.
4.3.2 Efficiency
Efficiency when looked at from a marginal cost perspective
would mean that: Only when prices are equal to marginal
costs is the economy squeezing the maximum output and
satisfaction from its scarce resources of land, labour and
capital. (Samuelson & Nordhuas: 139) In a perfect competition
market structure, the firm will set its production (performance)
at a level where the marginal cost equals the price, thus MC P .
In the case of imperfect competition the firm will depart from
marginal cost been equal to price, thus MC P or MC P .
Another

form

of

efficiency

is

technical

progress.

These

technological-considerations form one of the drives behind firms

attaining

efficient

sizes

and

effective

degrees

of

seller

concentrations.
5.

Testing the Structure Conduct Performance-paradigm

Economists used different sets of data over different periods of
time in an effort to test the validity of the structure-conductperformance paradigm.
Joe S. Bain constructed one of the earliest theories with regard
to the paradigm. Bain argued that successful collusion between
firms results in joint profit maximisation. In drawing such
conclusion he used data from the 1930s. In his analysis he used
42 industries divided into halves of most and less concentrated.

13

Stigler on the other hand argued that oligopolists wish to

collude in an effort to maximise joint profits. In an effort to
substantiate his findings, he used a sample of 17 industries
based on data from 1953-1957. His results shown a relationship
between profit rates and a four firm concentration ratio to be in
excess of 80%.
In contesting Bains theory, Mann used data from 1950-1960. He
used 21 industries, (half of Bains industries over a longer
period) and produced results similar to Bains. It could therefore
be argued that in using basically the same data in an
overlapping period (Bain 1953-1957: Mann 1950-1960) the
theory of Bain was justified for that spesific period. Weiss (1971)
did a further 23 studies on the subject which resulted in a weak
but

positive

relationship

between

profitability

and

concentration.
However, two economists named Brozen and Demsetz cast
doubt over Bains theory. Brozen argued that in case of
successful collusion in concentrated industries, above average
profits should persist over time, suggesting that the market be
in disequilibrium. He argued that profit rates in above average
industries will decrease and in below average industries it will
increase. The conclusions were derived from the data Bain used
between 1936-1940 and Stiglers data between 1953-1957. A
further study by MacAvoy, McKie and Preston led to the
argument

that

only

industries

with

persistently

high

concentration levels should be studied.

Demsetz approached the paradigm from another angle. He
argued that there are reasons other (examples; scales of

14

economy, efficiency, effectiveness etc.) than collusion for the

positive relations between profitability and concentration. He
justified his view by arguing that superior performance rewards
from a functional incentive based system.
Spandau did testing from a South African perspective. He used
a sample of 26 three-digit manufacturing industries based on
data from the Census of Manufacturing, 1976. Spandau used a
different method of computing profitability in the sense that he
measured profitability as percentage of gross output expressed
as a measure of wages and not sales as used in standardised
accounting principles. Despite the different method used by
Spandau it was found that there is a correlation between
profitability and concentration.
Other economists such as Samuels and Smyth covering 186
companies between 1954-63 found a negative relation between
profit rates and firm size. Hart and Barron who found similar
results from 1951 data supported these findings.
6.

Conclusion
Different types of concentration measures, of which absolute,
relative and summary measures, were used to draw conclusions
regarding the SCP-paradigm. The different measures led to
different conclusions, because of a lack of uniformed data. The
close relationship between the SCP-paradigm variables makes it
difficult to conclusively indicate whether structure leads to
performance or vice versa. However, it can be concluded that
the drive to be profitable forms an essential part of market
behaviour.

15

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Howe, S 1978. Industrial Economics, an Applied Approach.
London: The MacMillan Press Ltd.
Kamershen, RD 1969. Readings in Microeconomics. New York:
John Wiley and Sons, Inc.

16

Norton, WW 1968. Monopoly Power and Economic Performance,

The problem of Industrial concentration. New York: Norton &
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Reekie, WD 1984. The structure-conduct-performance paradigm
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Samuelson

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