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Market Structure of the Construction Industry

2267 words (9 pages) Essay in Economics

08/02/20 Economics Reference this

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Contents

Introduction

Construction Market Structure Overview

1. Perfect competition

2. Monopolistic competition

3. Oligopoly

4. Monopoly

Competitive Strategy

Porter’s three generic competitive strategies

Cost leadership

Differentiation strategy

Focus Strategy

Corporate & Innovative Strategies

Porters Five Forces Theory of Industry Structure

Conclusion

Referencing

Introduction

According to a recent analysis of the construction market published by AMA Research (2017), the UK has experienced good demand since 2013, with construction output increasing by 11% between 2014 and 2016.

Not only is construction one of the largest sectors of the UK economy, construction also has a much wider significance to the economy, creating and maintaining the economic infrastructure, the homes, schools and hospitals which serve the society (Department for Business Innovation & Skills, 2013).

A modern, competitive and efficient construction industry is essential to the UK’s economic prosperity. The extent of control over prices is determined by a number of factors which will be researched in further detail below. The main factor is the amount of competition in a market, which is, in turn, determined by the number of firms and type of construction project.

This research paper aims to discuss the market structure of the construction industry and assess the impact on competition, prices, and costs, while examining the competitive strategies available to large contractors in the UK.

Construction Market Structure Overview

Different industries have different market structures. The market structure reflects the state of competition in a market: how firms of different sizes are distributed and how firms are diversified into different submarkets in which the firms compete with each other.

Before a firm can compete in a market, it has to be able to enter it. Many markets have at least some impediments that make it more difficult for a firm to enter a market (Caves et al., 1977). An entry barrier has the effect of reducing or limiting competition.

There are currently few significant barriers to entry to the building industry for small firms, and such barriers will continue to be low while the industry maintains current practices based on a large number of small, specialised subcontractors.

Because there are only a limited number of contractors capable of managing large projects, the barriers to entry at this level tend to be significant and contractors are chosen based on track record, financial capacity and technical capability. This is due to the risks associated with running a complex project (De Valence, 2017)

Economists identify four market types, each one has a set of distinctive characteristics:

1. Perfect competition

Where there is perfect competition, there are a large number of firms and the output of any firm is small relative to market output. The market product is homogenous. Under perfect competition, there are many buyers and sellers, and prices reflect supply and demand.

The main characteristic is that neither the buyer or supplier can influence the price of the product, and there is a high rate of market transparency.

2. Monopolistic competition

Monopolistic competition incorporates features of both perfect competition and monopoly.

In a monopolistic competition, there are a large number of firms but their products are different. For example, according to de Valence (2017) there are subcontractors that have developed the characteristics of monopolistic competition for services such as heating, ventilation and air conditioning (HVAC). Medium size builders that operate in niche sectors of the construction industry and/or have developed relationships with repeat clients are also in this category.

3. Oligopoly

According to de Valence (2017) oligopolistic competition focuses on competition through product differentiation, or in the case of construction through the specialisation of particular types of projects such as high end residential, or infrastructure such as bridges, roads, etc., forms of procurement (e.g. design and build, traditional etc.), finance, or relationships with clients.

4. Monopoly

A monopoly is the opposite of perfect competition.

The degree of monopoly power exercised by the largest firms in an industry is expressed in the concentration ratio, which typically uses the largest four firms in an industry, ranked by market share or sales as a percentage of total industry sales.

The table below portrays the relationship between the construction industry and the three most relevant models of market structure, with the characteristics of each type.

Competitive Strategy

Strategy is a contested concept (Green et al., 2007). The generic literature on strategy is characterised by a diverse range of competing theories and alternative perspectives.

Traditional models of the competitive strategy of construction firms have tended to focus on external factors. Despite this, Green et al. (2007) emphasises the importance of internal factors like innovative capabilities of company or strategic management issues, etc.

According to Hampson et al (1997) for a contracting firm to stand out amongst its competitors, it can adopt one or more forms of competitive advantage—strategic management in construction, bidding strategy (choice of procurement method), technological and organisational innovation, technology strategy, strategic planning and strategic alliances (e.g. mergers & aquisitions).

Growth strategies deal with the expansion and growth of existing assets and improving productivity while developing the position of the company in the market.

Porter’s three generic competitive strategies

Porter’s three generic competitive strategies have been broadly used in the management field. Porter (1980) suggests that “…there are three potentially successful generic strategic approaches to outperforming other firms in an industry: overall cost leadership, differentiation and focus”.

Cost leadership

The cost leadership strategy was popular in the 1970’s and is based on a firm’s objective to become the lowest cost producer in its industry. Thompson and Stricklend (1995) describe how companies obtain cost leadership in two ways: (1) activities creating value and improving internal rate of return, (2) elimination of some insignificant cost parameters, for example this would include taking advantage of unskilled labour surpluses.

Cost leadership enables a firm to achieve an above- average performance in its industry.

Differentiation strategy

The differentiation strategy creates a product or service which is unique in an industry. Since the product or service is unique, the price elasticity of demand will be reduced.

“Differentiation can be based on the product itself, the delivery system by which it is sold, the marketing approach, and a broad range of other factors… a differentiator, therefore, must always seek ways of differentiating that lead to a price premium greater than the cost of differentiating… the logic of the differentiation strategy requires that a firm choose attributes in which to differentiate itself that are different from its rivals” (Porter, 1979).

Companies typically achieve differentiation with innovation, quality, or customer service.

Focus Strategy

When a company selects target markets for competition, this is known as the focus strategy according to Porter (1979). This strategy enables a company to better meet the needs of a specific market rather than compete more broadly. It is important to select the appropriate target market to implement this strategy. Often, it’s a tiny niche that larger companies may not necessarily serve. Ercan (2013) refers to Porter’s (1979) description of the focus strategy as segment structural attractiveness. Most industries have a variety of segments and some segments in an industry are much less profitable than others.

Corporate & Innovative Strategies

Construction companies are having to use corporate strategies which includes long-range plans, methods and approaches adopted to reach the company’s goals and to gain competitive advantage.

Innovation strategies can be described as R&D investments, organisational learning and use of new technologies in operations and organisational processes.

Bossink has emphasised that concept of innovation has a great impact on competitive strategies and furthermore it has been demonstrated in studies that while innovation is increasingly becoming important for the long-term success of the company, construction companies are all too often not putting such strategies in to practice (Ercan, 2013)

Valence (2010) claims that there is pressure within the construction industry to become more innovative, speed up construction, and deliver better value for money for clients, however there are certain characteristics of the industry that appear to slow progress and make innovation difficult.

Seadan et al. (2003) examine the relationship between strategies and innovative practices and noted that recent years innovation strategies became more important for gaining competitive advantage.

According to Porter et al (1985) the information revolution is affecting competition by changing industry structure which therefore changes the rules of competition. Innovation strategies create competitive advantage by giving companies new ways to outperform competitors.

Porters Five Forces Theory of Industry Structure

Essentially, Porter’s Five Forces of Competitive Position Analysis (1979) is a method to evaluate the competitive strength and position of a business organisation.

This can be of use both in understanding the strength of an organisation’s current competitive position, and the strength of a position that an organisation may be interested in moving to.

Strategic analysts often use Porter’s five forces to understand whether new products or services are potentially profitable. The theory can also be used to identify areas of strength, to improve weaknesses and to avoid mistakes.

The five forces are: Supplier power; Buyer power; Competitive rivalry; Threat of substitution; Threat of new entry.

Conclusion

To summarise, the market structure of the construction is determined by:

  1. The number of firms in the market.
  2. The nature of the product.
  3. The extent of information available to market participants.
  4. The freedom of entry and exit, existence of barriers to entry.

Some parts of the industry fit the perfect competition model, such as small and medium size contractors. However, it must be noted that the construction industry is also highly concentrated with a small number of large contractors.  At this level the industry is oligopolistic, with high barriers to entry due to the heightened levels of risk/importance associated with the project and the prequalification checks used by clients to select contractors for major projects.

Between these two market structures there are some firms in the industry that are in monopolistic competition. This includes contractors that have specialised and differentiated their product from others, or have contractors who have developed ongoing relationships with clients and are not considered to be in the price-driven competition end of the business (Valence, 2017).

The competitive strategy adopted by large UK construction companies tends to differ from company to company but according to Porter (1980) a “company must create clear goals, strategies, and operations to build sustainable competitive advantage and the corporate culture and values of the employees must be in alignment with those goals”.  Hampson et al (1997) go as far to say that contractors are likely to benefit from more cooperative arrangements with their subcontractors to create and enhance competitive advantage in building construction.

From the research conducted, it seems that construction management studies are generally more descriptive rather than quantitative.

Empirical studies need to be performed on the entire construction market structure to better understand the market and to formulate effective strategies.

Referencing

  • Bossink, B.A.G., “Effectiveness of innovation leadership styles: a manager’s influence on ecological innovation in construction projects”, Construction Innovation, 4(4):211-228 (2004).
  • Caves, R. E. and M. E. Porter (1977) From entry barriers to mobility barriers: Conjectural decisions and contrived deterrence to new competition. Quarterly Journal of Economics 91: 241-62. Ison, S. & Wall, S. 2007. Economics (4th Ed)
  • Caves, R.E., “Multinational enterprises and technology transfer”, in Rugman, A.M. (ed.) New Theories of the Multinational Enterprise, St Martin’s Press, New York,254–79, (1982)
  • Green, S.D., Larsen, G.D., Kao, C-C, “Competitive strategy revisited: contested concepts and dynamic capabilities”, Construction Management and Economics, January (26):63–78, (2008).
  • Hampson, Keith D. and Kwok, Tommy (1997) Strategic alliances in building construction : a tender evaluation tool for the public sector. Journal of Construction Procurement, 3(1). pp. 28-41.
  • Porter, M.E., “Competitive Advantage”, Free Press, New York, (1985)
  • Seaden, G., Guolla, M., Doutriaux, J., Nash, J., “Strategic decision and innovation in construction firms”, Construction Management and Economics, 21(6):603-612 (2003).
  • Thompson, A. A., Jr. & Strickland, A.J. III., “Strategic management concepts and cases”, 8th ed., Chicago, (1995)
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