To view annual reports as having limited value in assessing the
competitive structure of an industry is to overlook a rich source of
information regarding a company's view of its competitors along with
business transactions and financial results that can be highly
suggestive. To assess the competitive structure, one seeks to
understand whether perfect or imperfect competition exists. In the
case of perfect competition, "...no producer can affect the market
price. Under perfect competition, there are many small firms, each
producing an identical product and each too small to affect the market
price," (page 141). "Imperfect competition prevails in an industry
whenever individual sellers have some measure of control over the
price of output in that industry," (page 163).
Under imperfect competition, three types of market structures are
common. "The market structure of an industry denotes the
characteristics of an industry, particularly the number and size of
the sellers, the extent of concentration among the firms, and the
degree of homogeneity or heterogeneity of their products," (page 164).
The most extreme case of imperfect competition is the monopoly, where
a single firm exercises complete control over an industry. "It is the
only one producing in its industry, and there is no industry producing
a close substitute," (page 164). Very few true monopolies currently
exist. Municipal water supplies are an example.
Oligopolies exist in one of two forms. An oligopolist may be one of a
few producers whose products are nearly or completely identical.
Although none of the firms have a monopoly, their small numbers allow
each to have tremendous influence over market price. This type of
oligopoly is prevalent in basic materials industries where products
are fairly homogenous and the companies are large. Because of the
high capital requirements, the costs of entering the industry are
large. Examples include the aluminum and oil industries.
Another type of oligopoly exists when an industry is composed of a
limited number of sellers having differentiated products. Although
the important characteristics of the products vary, they are close
substitutes for one another. Virtually all consumer commodities have
this characteristic, whether it be automobiles, refrigerators, ice
cream, or T-shirts. In this type of oligopoly, even though
competition is between only a few firms, it can still be fierce.
The last type of market structure, called monopolistic competition,
involves a large number of sellers producing differentiated products.
This market structure closely resembles perfect competition because
there are many competing companies, none of whom have a large market
share. However, it differs from perfect competition because the
companies' products are differentiated instead of being identical.
The market for retail gasoline is an example of monopolistic
competition. Differentiation arises primarily from location, but can
also be based on differences in quality, in brands or trademarks, or
in styling.
What can annual reports tell us about the state of an industry's
market structure? First, one must define what one means by annual
report. For the purposes of this discussion, I am considering annual
report to encompass both the publication sent to shareholders and the
firm's Form 10-K filing with the United States Securities and Exchange
Commission. Because I have copies of both publications from i2
Technologies from 2001 readily at hand, I will refer to them as
examples.
First, let us consider the "i2 Technologies 2001 Annual Review," which
is the annual report that was mailed to shareholders. The review
begins with the presentation of selected five-year statistics. An
examination of the firm's revenues shows rapid growth followed by a
sudden decline. We can also see that the firm has a very large
percentage of its employees devoted to research and development.
Breakdowns are also provided for sales by industry and by region.
Although the majority of sales occurred in United States, it is
interesting to note that a relatively small company is nonetheless
gaining more than one third of its sales overseas.
The review continues with a statement from the CEO discussing the
firm's performance. He describes some of the difficulties the firm
encountered from the sudden change in the economy and disruptive
geopolitical events that occurred in 2001. He mentions that the
company has hired a third-party firm to conduct customer surveys for
the first time and emphasizes the importance of customer service. He
discloses that partnerships with other software, hardware, and
consulting firms resulted in more than half of the company's new
business. He also discusses his commitment to leading the market and
the company's multiple acquisitions that occurred during the year.
The review concludes with a discussion of the firm's products, which
positions them as being uniquely capable, and customers. The review
discloses the company's domination of supply chain management software
sales in high-tech, auto manufacturing, metals, pharmaceutical
companies, and aerospace and defense companies. In contrast, much
less strong language is used to describe the company's activities in
retail and consumer goods.
From the review, we can deduce that the company probably competes in
monopolistic competition, although in certain market segments where it
is strong it desires to acquire monopolistic characteristics. The
company positions its products as being highly differentiated, and it
spends a substantial part of its resources on research and
development. This spending is also indicative of a competitive
marketplace. Furthermore, the company competes worldwide even though
it is not all that large, which indicates that significant competition
exists at home. The essential role of partnerships with other
companies also indicates that the firm is one of many competing in its
marketplace instead of being the only source for the type of products
it sells. Furthermore, the new emphasis on customer service may
indicate that new competitors have entered the marketplace, which may
also play a role in the firm's abrupt financial reversal. Finally,
the multiple acquisitions during the year is evidence that there are
multiple small competitors in the marketplace.
The firm's Form 10-K provides more detailed information that further
bolsters our initial impressions of the firm's industry's competitive
structure. In the Sales and Marketing section, the company reveals
that it has joint marketing agreements with over 60 software vendors
and e-business providers to increase the market coverage of its
products. In the International Operations section, the firm reveals
that 20.2% of its total consolidated assets excluding intangible
assets are related to its international operations. In the
Competition section, the firm indicates that the markets in which it
operates are very competitive, with many diverse competitors that
target various segments in which it competes. Many different types of
competitors are listed, including large ERP software vendors,
companies focused primarily on supply chain management applications,
companies focused primarily on supply relationship management
applications, companies focused primarily on customer relationship
management applications, companies focused principally on content and
content management applications, and internal development efforts by
corporate information technology departments.
More information about competitors is presented under Factors That May
Effect Future Results, such as the fact that competitors may have
longer operating histories, greater resources, superior product
functionality in specific areas, greater brand-name recognition, a
broader range of products to offer, and a larger installed base. The
firm also notes that it is critically dependent upon partners and
other third parties for a substantial part of its revenue, some of
which are either actual or potential competitors. Additional
information about the firm's acquisition activity is disclosed,
indicating that two firms were acquired during 2000. In the Notes to
Consolidate Financial Statements, it is revealed that other businesses
were acquired 2000, 1999, and 1998. In addition, software assets and
software licenses were acquired from IBM in 2000.
From the firm's Form 10-K, it is clear that our initial assumptions
made from the Annual Review were correct. The material regarding
competitors, partners, and acquisition activities supports the notion
that the firm's industry is in a state of monopolistic competition.
The ease with which one can extract evidence for the industry's
competitive structure clearly illustrates how valuable annual reports
are for this purpose. Especially when annual reports are available
for multiple firms in an industry, a great deal of insight can be
gained into how an industry is structured.
Sincerely,
Wonko
References:
All quotations were taken from Economics, 14th edition, by Samuelson &
Nordhaus, McGraw-Hill Inc., 1992
"2001 Annual Review" i2 Technologies
http://www.i2.com/assets/pdf/A94AF0DB-FFF4-4852-8C5D9ACCB3E6B7CE.pdf
"Form 10-K" Edgar Online
http://www.edgar-online.com/bin/edgardoc/finSys_main.asp?dcn=0000950134-01-002764&nad= |
