Contestable Market Theory

What is the contestable market theory

Well, generally, this is an economic concept that says companies that have very few rivals in the competitive market

tend to behave in a highly competitive manner, particularly when the conditions for entry and

exit from the market are very weak. That is, it is easy for new entrants to enter into the market

The existing firms in the market are going to be highly competitive in nature

Now, the implication or assumption here is that there's always potential threat of market entrance from new rivals

So with that being said, what are the primary characteristics that you see in a contestable market

Well, one, you have to have freedom of entry and exit from the market. So existing players can exit the market at any time with relative ease

and new competitors can enter the market with relative ease. There's not high barriers to entry or barriers

to exit, as they say. There's an absence of irrecoverable incurred costs for exiting the market

This is one of those barriers to exit. So there's, once again, an absence to barriers of exit

And irrecoverable cost is one of the biggest barriers. You see this in industries that have extremely heavy capital expenditure

such as heavy equipment like airlines or other major construction. firms that have to buy massive amounts of equipment for a particular job or undertaking

And then there's equal access to technology by new entrants and market participants

That is, so anyone entering into the market can immediately have access to the things they need

to adequately compete. You see this in the real estate industry routinely

That is the multiple listing service the ability once you enter into the market as an agent you have access to this technology that gives you access to listings for properties So once again a very important aspect is

equal opportunity to compete. And this comes with access to technology. And then lastly, there is a

tendency towards hit and run tactics, as we say, that is, new entrance into the market, quickly

come into the market, do things that give some level of temporary strategic advantage

such as charging very low prices or doing some kind of combined sales or product offering in the

short run that produces profits quickly and then they can quickly exit the market

The reason for this is oftentimes it's very difficult to establish long-term competitive advantage

in a market. That is, the other competitors will routinely react to whatever you do when you enter the

market and start to compete. many firms will jump into the market, try to take advantage of immediate arbitrage opportunities

and make a quick profit. And then once that opportunity has exhausted itself, that is, the

market forces are starting to react or some type of door closes on that opportunity, they'll

then quickly exit the market. But the essence of this is it keeps existing competitors in the

market on their toes in a way. That is, they have to quickly react to all of the new and

novel things happening by new entrance into the market to fight them off to keep them from

establishing that long-term competitive advantage that's going to erode some of the existing

competitors market share. So in this way, in summary, Contestable Market Theory simply says that

if you have a market where there is value to be grabbed, there will be new entrance into that

market, and because of that, there will be a high level of competition among existing firms

in the market