Economics of Computers

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Economics of Computers

Introduction and Background The computer service industry can be broken down into several categories ranging from reseller to consultant. Entré Computers / Executive Business Machines Inc. (EBM) was a sales and service organization for typewriters at its inception in 1972. However, as the corporate market shifted its needs from typewriters to word processors to personal computers, so did EBM change its product line to meet that demand. Now they are trying to compete in a very competitive low margin industry. They are a small single location company with annual gross revenues of twenty million (USD). However, as the profit margin and price of their product continually drop at a rate of forty percent annually, it becomes more difficult to show increasing gross revenues. They will need to find a place in the market, a niche, to survive and effectively compete with larger internationally known corporations as well as small local companies that are very much like their own. Industry Structure, Competitors The market is extremely competitive price-searchers market; product is often sold below manufacture's cost just to maintain market share and brand loyalty. It is a competitive price-searcher market because of the low barriers to entry and no regulations in price. Firms in this market are faced with a downward-sloping demand curve. The sellers range from international organizations, which retain over twenty thousand employees, to very small local shops with as few as two workers. The low-end of the market could be considered a Natural Monopoly because the average costs of production are continually decreasing as a result of higher production, improved technology and increased competition. However, there is a high end of market that would be deemed an Oligopoly, because it consists of a small number of sellers due to a very high barrier to entry. Typically the differentiated products are custom-built solutions that can only be provided by companies of the size and stature of a big six consulting firm or an internationally know organization such as Oracle or SAS. There are very high barriers to entry to compete in this market since the clients to this product are looking for large-scale international support. In order to implement a sophisticated differentiated product like Oracle financials or SAP, a company needs to retain an enormous overpaid staff of software engineers to develop, support, and implement such solutions. Very few companies are capable of retaining and / or attracting the staff necessary to provide such solutions.

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However, every large company is dependent on this information technology to maintain their financial, budget, inventory, production, and customer information. Just as most Americans are dependent on our automobiles for transportation. I make the comparison to the automobiles because the automobile industry is an excellent example of an oligopoly. The computer industry is an example of a competitive price-searchers market because firms can freely enter and exit the market and profits and losses play an important role in determining the size of the industry. Economic profits are attracting new competitors to the market. The increased availability of the computers and software are driving the price down until the profits are almost completely eliminated. These economic loses are beginning to force competitors to exit from the market. Eventually the decline in available computer related service would allow Information Technology (IT) firms to increase their price until they are able to cover their total costs. Change in Demand The demand curve of the IT industry is a downward slope due to the change in revenue caused by a price-searcher market. A firm faces this curve because of the price reduction that causes increased sales will exert two conflicting influences on total revenue. First, total revenue will rise because of an increase in the number of units sold. However, revenue losses from the lower price on units that could have been sold at a higher price will at least partially offset the additional revenue form increased sales. Therefore, the marginal revenue curve will lie inside the firm's demand curve. Although there are continuous price cuts on computers, the demand for PCs in the workplace will remain fairly consistent however, the demand for PCs in the home will increase as the unit price decreases. Since the home market account for less then twenty percent of total computer sales world wide, it shows very little affect on the demand curve. The market appears to be only slightly elastic because the price is decreasing and the demand curve is barely affected. Virtually every corporate employee has a PC. Most companies will hold to that policy despite drastic price drops. However, as the total cost of owner ship decreases with the purchase price and the rapidly changing technology, the expected life of a PC is shortened. This will show an increase in unit sales over a three-year period but that curve would only be a forecast. The Year 2000 Bug (Y2K) has caused a lot of activity in the IT market. I use the word activity because the increase in corporate IT budgets and IT sales and service is short term and should not be used to determine the growth rate of the industry. However because there is a low barrier to entry, new rivals are drawing customers away from established firms. These new companies are forcing the demand curve to shift inward, thus minimizing and in some cases eliminating profit. When the Y2K activity dissipates, many of the smaller firms will go out of business or will be acquired by larger firms. Acquisition is the most popular and efficient way to grow an IT firm right now. It enables the firm to procure qualified engineers and technology, both of which are very expensive to develop and / or obtain. Many startup IT companies begin their business plan with their exit strategy, knowing or hoping that they will be purchased by a large organization such as Microsoft or one of the big six consulting firms. Because there are low barriers to exit, acquisition provides an easy and profitable market exit for the company's principles.

Company Strategy EBM is currently looking for a secure strategy in a rapidly changing industry. They are trying to adjust their profit margin accordingly to remain competitive in their contestable market. They will be more dependent on customer loyalty then ever before. If they intend to survive past the point of zero economic profit in the price-searches market curve, their new corporate strategy should force them to operate more efficiently, cater to the preferences of their clients, and develop better/ more improved products at a lower cost. They must also evaluate and implement the type of corporate structure and size that will maximize economic efficiency. Because entry is low and activity is high, new competition will continually appearing. These new rivals will attempt to increase their market share. This can only be accomplished by taking clients away from other firms. Therefore EBM must be committed to customer satisfaction and should look to develop an incentive program for existing clients. EBM should implement an incentive program that will entice their existing clientele to buy IT related goods and services exclusively from them. For example, discounts and added services would be available to customers whose purchases exceed a predetermined amount of sales annually. A referral program for clients that recommend new or potential clients to EBM would be an example of another idea. EBM should look to cater to the specific needs of their customers. This can be done in several different areas. They currently provide that extra service and support for all of their clients, however there are many other ways they can improve the customer's experience with them. For example, commerce is an inexpensive way to cater to the customer with a minimal investment. Some clients may prefer to pay with a credit card, net 30 terms, or electronic funds transfer.

These practices are inexpensive to implement and are not yet in use by all of EBM's competitors. Another alternative that EBM could offer is shopping and purchasing IT related goods and services over the Internet. This would allow the customer to make more educated decisions without the pressure of a sales person. It could also enable EBM to process more sales without increasing their sales staff, thus keeping actual total cost the same while increasing total revenue. Because economic profits will increase as fixed costs decrease, EBM should evaluate the size the structure of their company to be sure it is as efficient as possible. They should also reevaluate many of their fixed costs such as rent, phone costs, and administrative personnel. The telephone industry is also becoming a competitive price searcher market and better deals can be found everyday. Most importantly, EBM must search for a niche were they can have market power. In order for a small local company, that does not have unlimited financial resources, to compete in a competitive price-searcher market it must find a unique product or service to offer. If this product or service caters to a small enough market, it will protect the small company from re-entering the price-searcher market. For example, this product may be used by near-surgeons during brain surgery. If the product is good enough to become a standard in the field and market remains small then it is unlikely that other seller will risk making an investment into that market. Therefore, if the number of sellers and number of customers remains small then there will be very little competitive pricing. This monopoly market will allow EBM to keep their product profit margins high. However since there is not any capital for research and development in this small organization, they will have to ramp up to service and deliver a product that is not yet adopted as an industry standard. This will allow them to stay ahead of the price-searchers curve. If they have chosen an appropriate and soon to be accepted technology then other sellers will soon provide this product and service as well. This will force prices down once again until there isn't any economic profit. If this company insists on embracing this industry then they will have to accept the level of competition that exists in that market. They should look to do more research into industry trends and always be prepared to jump on the rumor of new break-though technology. However, they will also need to be prepared to abandon poor choices and areas of the industry that do not show any economic profit. This will greatly affect the organization in regards to its structure. A corporation that intends to be this flexible will have to have a very lean administrative staff and often replace the existing staff with experienced sales and technical engineers in the newly adopted field.


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