ACTIVITY 3 Case study 2: Microsoft – increasing or diminishing returns? In some industries, securing the adoption of an industry standard that is favourable to one’s own product is an enormous advantage. It can involve marketing efforts that grow more productive the larger the product’s market share. Microsoft’s Windows is an excellent example.2 The more customers adopt Windows, the more applications are introduced by independent software developers, and the more applications that are introduced the greater the chance for further adoptions. With other products the market can quickly exhibit diminishing returns to promotional expenditure, as it becomes saturated. However, with the adoption of new industry standards, or a new technology, increasing returns can persist.3 Microsoft is therefore willing to spend huge amounts on promotion and marketing to gain this advantage and dominate the industry. Many would claim that this is a restrictive practice, and that this has justified the recent anti-trust suit against the company. The competitive aspects of this situation will be examined in Chapter 12, but at this point there is another side to the situation regarding returns that should be considered. Microsoft introduced Office 2000, a program that includes Word, Excel, PowerPoint and Access, to general retail customers in December 1999. It represented a considerable advance over the previous package, Office 97, by allowing much more interaction with the Internet. It also allows easier collaborative work for firms using an intranet. Thus many larger firms have been willing to buy upgrades and pay the price of around $230. However, there is limited scope for users to take advantage of these improvements. Office 97 was already so full of features that most customers could not begin to exhaust its possibilities. It has been estimated that with Word 97 even adventurous users were unlikely to use more than a quarter of all its capabilities. In this respect Microsoft is a victim of the law of diminishing returns.4 Smaller businesses and home users may not be too impressed with the further capabilities of Office 2000. Given the enormous costs of developing upgrades to the package, the question is where does Microsoft go from here. It is speculated that the next version, Office 2003, may incorporate a speech-recognition program, making keyboard and mouse redundant. At the moment such programs require a considerable investment in time and effort from the user to train the computer to interpret their commands accurately, as well as the considerable investment by the software producer in developing the package. Questions 1 Is it possible for a firm to experience both increasing and diminishing returns at the same time? 2 What other firms, in other industries, might be in similar situations to Microsoft, and in what respects? 3 What is the nature of the fixed factor that is causing the law of diminishing returns in Microsoft’s case? 4 Are there any ways in which Microsoft can reduce the undesirable effects of the law of diminishing returns? Case study 3: Price cuts for medicines Chemists at risk as prices are slashed BY NIGEL HAWKES, HEALTH EDITOR Big price cuts on a wide range of medicines and vitamins were promised by the supermarket chains yesterday as 30 years of price-fixing were swept aside. Many popular products, including painkillers, cough medicines, indigestion tablets and nutritional supplements are being halved in price from last night, with reductions of between 20 and 40 per cent on many others. The Office of Fair Trading called it excellent news for consumers but the body representing small pharmacies said that many would close, threatening community services. The big supermarkets trumpeted ‘millions of pounds-worth of savings’ as they competed to offer the biggest reductions. At Asda, a packet of 16 regular Anadin will be 87p, instead of £1.75, and Nurofen tablets will cost £1.14 for 16, rather than £2.29. Reductions at Tesco included a 40 per cent cut in Anadin Extra, to £1.29 for 16, while Sainsbury’s matched the Asda price for Nurofen, and reduced Seven Seas Evening Primrose Oil from £5.59 for a 60-pack to £2.79. The cuts came after the Community Pharmacy Action Group, representing small retailers, withdrew its opposition to a High Court action brought by the Office of Fair Trading. The OFT had sought the abolition of resale price maintenance in the industry, exempted 30 years ago from general price-fixing rules to try to ensure the survival of small pharmacies. There are 13,500 pharmacies in Britain, of which 9,000 are small shops serving local high streets and rural communities. The action group backed out after Mr Justice Buckley said that he believed there was insufficient proof that a large number of independent pharmacies would close, or that the range of products would be reduced. But the group’s chairman, David Sharpe, said that the outcome would be a devastating blow. ‘Many pharmacists will simply not be able to survive given the buying power and aggressive pricing of the supermarkets’ he said. ‘It’s a sad day for Britain. The potential losers are the elderly, disabled and young mothers who rely on the free advice and range of services offered by the local pharmacist. We’ll fight on and hope the public will remain loyal.’ The changes will cover about 2,500 products sold without requiring a doctor’s prescription, and will have no effect on prescription drugs or on cosmetics sold by pharmacists. Prices are likely to fall even lower as competition grows. In the United States, where prices are unregulated, comparable products are markedly cheaper. Richard Hyman, chairman of the Verdict retail research consultancy, said: ‘This is a market made for supermarkets. Medicines are small, they fit on shelves and supermarkets are going to make a lot of noise about the great prices that they will be offering. Soon medicines will become like any other product and be part of the weekly shop.’ John Vickers, Director-General of Fair Trading, said: ‘This is excellent news for consumers, who will now benefit from lower and more competitive prices for common household medicines. Consumers will save many millions of pounds a year.’ The Proprietary Association of Great Britain, which represents medicine and food supplement manufacturers, said it was disappointed. Questions 1 What kind of market structure is involved for the sale of medicines and vitamins? 2 What can be said about barriers to entry in this market? 3 Might there be a change in market structure after the change in the law? 4 Explain the disadvantages of the abolition of resale price maintenance (RPM) for this market. 5 When RPM was abolished for book sales in 1995, the same concerns as those expressed in the above case were voiced. Since then, 10 per cent of bookshops have gone out of business. What conclusions might this help you to draw regarding the future of small pharmacies? 6 How does the rise of the Internet affect this situation? Case study 4: PC World PC World is a major retailer of computers and related equipment in the United Kingdom, calling itself ‘the computer superstore’. The market features much heavy advertising by different types of seller: Time, Tiny and Gateway, who put together their own packages of components under their own names; Dell, which produces custom-made packages as well as standard offers; and retailers like Dixons and Comet which sell a variety of appliances. However, PC World probably out-advertises them all with its regular full-page spreads in the major national newspapers. Because of the nature of the product most of the advertisements feature packages at a special sale price. These packages often include a variety of software, and sometimes items like printers and scanners. The featured computers are highly competitive in terms of price, and include most major manufacturers, like Compaq, Packard Bell, Advent, Hewlett Packard, Apple and Sony. The company has been expanding in terms of size and profit for several years. While many customers have been very happy with the deals that they have obtained from PC World, some of them claim that the end cost has considerably surpassed their initial expectations. There are several reasons for this. 1. Some of the add-ons that they want to buy are not available with the deals on offer; sometimes the add-ons in the special offers include low-quality or obsolete items, causing one to suspect that the firm is just trying to get rid of these items by packaging them with others, since nobody would want to buy them separately. Similarly, the packages often do not include the most desirable software. Thus, even with a seemingly complete offer, the buyer may end up having to buy several additional items to obtain the system they really want. 2. The firm tries to hard-sell its extended warranty scheme. Depending on the package purchased, this can increase the cost by 5–6 per cent. This tactic is by no means exclusive to PC World. Several electrical appliance retailers in the UK, particularly Dixons and Argos, are currently under investigation by the Monopolies and Mergers Commission because of their alleged excessive profits in this area of activity. 3. The credit terms can be misleading. Often a lengthy period of interest-free credit is offered, like nine to twelve months. It is highly attractive to many buyers to buy something costing over £1,000 and not to have to pay anything at all for such a long period. These credit terms are offered through HFC Bank. The problem is that people are not notified at the end of the interest-free period, and they then become liable to pay interest on the whole purchase price from the date of purchase at a high interest rate, close to 30 per cent annually. The result is that the unwary consumer can end up paying about twice the original purchase price over a period of four years. Questions 1 Describe the various complementary products, both goods and services, that a consumer may consider in buying a computer system. 2 Compare and contrast the situation of PC World with that of a supermarket chain, as far as product mix profit maximization is concerned.
