Relevance of Structure-Conduct-Performance (SCP) Hypothesis
Initially, the market structure and performance framework was consequent from the neo-classical analysis of markets. The SCP Paradigm was the conception of the Harvard school of thinking and generalized during 1940-60 with pragmatic work involving the classification of correlations between the structure of the industry and performance. The working of the SCP has led to the execution of the anti-trust legislation. This was then followed up from the Chicago School of thought from 1960-1980. They accentuated the coherence for firms growing big, the price theory and econometric evaluation.
During the eighties and nineties, the game theory came into the limelight with greater emphasis on strategic decision making and the Nash Equilibrium theory. Late in the nineties experimental industrial organization with the use of complex economic philosophy and econometrics led to complex observed modeling of technological changes, merger investigation, identification of market power and entry-exit. There are basically two broad contending hypotheses in the SCP model: the customary structure performance hypothesis and the efficient structure hypothesis.
Firstly the structure performance hypothesis states that whatever the degree of market concentration it will inversely relate to competition. The reason for this is because market concentration will usually persuade firms to collude. And precisely the standard
Need essay sample on "Relevance of Structure-Conduct-Performance (SCP) Hypothesis"? We will write a custom essay sample specifically for you for only $ 13.90/page
This hypothesis however will only be proved if a positive relationship between market concentration which is measured by the concentration ratio and performance which is usually measured by profit levels exist. Regardless of the efficiency of the firm which is measured by its market share. Therefore firms located into more concentrated industries will earn higher profits then firms in less concentrated markets, irrespective of their efficiency levels. (Purkayastha, n.p.)
The efficiency structure model on the other hand states that the obvious performance of the firm should be positively related to its efficiency. Simply because market concentrations transpires from competition where organizations with low costs tend to increase profits by a reductions in price and an increase in market share. A positive bond between a firm’s market structure and profits is credited to the gains made in market share by efficient firms. In turn, these financial gains lead to a heightened market concentration level. This means that higher profits are understood to add to more efficient firms, not because they are collusive but more efficient as the traditional SCP would state.
Conventionally, these hypotheses have been scrutinized using measures of profit or profit margins as main indicators of performance. On the other hand in the efficiency/productivity text there is more emphasis on the use of efficiency to determine and examine the economies of scale, scope and both economies of scale and scope, policy implications and accounting for risk. The use of Stochastic Frontier efficiency measures as an alternate for performance to demonstrate the SCP hypothesis and structure efficient hypothesis.
To explain the SCP in further detail, firstly structure which refers basically to market structure, the many variables that help in determining market structure includes retailer concentration, barriers of entry and exit and product differentiation. These variables can be further classified intrinsic structural variables which solely determined by the nature of the product and prevalent technology and derived structural variables which are dependent on firms and governments which include buyer seller concentration and barriers to entry and product differentiation. This distinction may be necessary is the intrinsic structural variables are exogenously determined.
Secondly conduct, which basically refers to the behavior of firms the variables include advertising trends, collusion behavior and pricing strategies, research and development and investment patterns. In the simplest form of interpretation conduct can be determined if a firm competes or colludes. And lastly performance, which refers to the level of allocative efficiency determined, the variables used are usually profit levels and profit margins. In theory market structure determines conduct which helps determine performance. (Lee, np)
The banking industry in the nineties focused mainly on the experiential testing of the effects of the banking concentration and competition using the conventional structure-conduct-performance hypothesis on the US banking sector. The SCP hypothesis deduced that banking concentration and other obstructions to competition create an unfavorable environment for banking operations from a societal viewpoint. This research mainly concentrated on measuring prosperity as endogenous measures of bank conduct and performance. The focus remained on the whole industry and not individual banks.
During the same era, the business strategy sought testing evidence to specify the authenticity of competitive advantage. Many research were conducted to advantage that would help industries in general. The aim was to identify factors not and not to specifically point out their relationship to performance. Berger and Haubrich pointed out tat the banking literature now needs to include aspects from the strategy literature. Recently research has moved across the SCP hypothesis, and examined a number of competing models. The measures of conduct and performance that are scrutinized have now included a number of indicators like efficiency, risks of banks, service quality and consequences incurred by the whole economy.
The basic parameter of the SCP paradigm is that the economic performance of a sector is the primary function of the buyers and sellers which is therefore the function of the economy’s structure. In most cases performance is measure in terms of maximization of welfare, conduct in the broadest prospect refers to the activities conducted by the buyer and seller. Seller activities usually include utilization and installation of capacity, promotional and pricing policies, R&D, intra firm competition or collusion. Industry structure in one of the main determinants of conduct and includes the size of the market, the level of technology and product homogeneity, the level of integration and barriers to exit and entry.
The idea of business organization from the S-C-P paradigm has clearly been working in the development of nonspecific strategies and business typologies. Porter states clearly, In the long run, the velocity of return obtainable from challenging in an industry is a function of its fundamental structure. Further, Porter lists effortlessness of entry as the first of five determinants of industry charisma, and White suggests that the most trendy business strategies or typologies are based on assessing and detecting the magnetism of an industry.
Others point toward that a firm’s ability to earn greater profits is reliant upon strategies that make industry configuration more attractive. in the literature of the SCP paradigm, the development of business plans seems to be a function of certain characteristics of the industry.
The success of any given plan in directly proportional to its ability and willingness to commence activities that erect barriers to entry and increased level of concentration. the height of the barriers to entry depicts the extent to which superior profits can be obtained. Many diversifications in research of mergers and acquisitions also make the direct and indirect use of the SCP paradigm hypothesis. For example Montgomery and Singh hypothesize that the act of diversification may be a direct function of barriers to entry. it is basically suggested that increased level of concentration and complete and absolute cost barriers are not linked with diversification.
This complex view of diversification underlies the test of return to related versus unrelated diversification. It also indicated that certain merging strategies can be linked to characteristics of the structure, to be more specific, barriers to entry of all the participating firms. It is clear that facets of the SCP paradigm have been incorporated into the normative measurement of Premeditated Management as well. Industry arrangement and its influence on accomplishment is an idea that permeates the strategic development text. The limitations of the SCP paradigm exist. While such a hypothesis is usually used in formulation of research strategy.
The SCP model has many weaknesses and limitations firstly the wrong level of analysis, secondly the use of very static analysis and thirdly a heavily dependent on the barriers as a means of determination of profits. In a way of speaking about predictability these weaknesses can be costly for both practitioners and researchers. As a foundation for hypothesis expansion, the amalgamation of the S-C-P paradigm has consequence in strategy researchers using the wrong level of analysis . The S-C-P paradigm was urbanized to explain and envisage industry level observable fact and makes the postulation that all the firms contained by an industry are homogeneous (Purkayastha, n.p.)
The general objective of this analysis was to review the production function and the market structure, conduct and performance (profitability) of the banking industry in the United States by using available data for the period 1994-2003. To accomplish the objective of this study, we approximated stochastic frontier production task and SCP model with output and efficiency procedures as endogenous changeable with Battese and Coelli specification to test the belongings of several variables, including but not limited, to jeopardy, concentration, market shares of the firms, and transition expenses, on the prosperity of the firms measured in terms of efficiency.
The basic argument underlying this explore is that firm financial and in use performance data can be used as representative indicators of the determinants that constitute the essence of profitability from the efficiency paradigm. Therefore, each variable included in this analysis was represented by a financial and/or operating statistic. Data and information needed to accomplish the purpose of this study came from the electronic media.
Results from this study indicate that quite a few inconsistencies in this study have statistically significant impact on the efficiency measures.
Reasons and Consequences of Mergers and Acquisition on Banking Industry
The US banking industry is in the middle of a consolidation process is likely looking to reduce the no of its banks by about 25% before the end of this decade. Bank merging activities sharply rose to ground breaking levels in 1995. This movement resulted in an increase in bank stock prices commendably more than the industrial average. Adding to the consolidation phase is the introduction of an interstate banking bill, a diminishing rate of revenue opportunities in a slowing economy, the age old problem of credit quality, and cost reduction potential following mergers.
The banking industry is undergoing a sort of revamping. This movement is due to many factors (1) the large number of banks that thrift failure in the nineties, (2) the deregulation that results in a technological change and, (3) the urge to improve profits by better serving customers more efficiently and increasing avenues of revenue. Mergers and acquisitions greatly reduce the number of banks in the country; the main form of removing declining banks was the passage of the St. Germain Act by through judicial ruling. Banks on the other hand were hunting for additional profitability through growth, economies of scale through increased volumes of operations.
The anticipation of spreading costs over a larger clientele, diversification in the form of products and geographical client base, stabilizing asset quality and lastly higher value for their equity. On the other hand banks not only purchase the depository institutions but also mortgage banking companies, financial companies, mutual fund holders, brokerage companies and mainly financial companies which allow them to earn fee income which then permits them to move away from dependence on interest income. The above factors will likely compel in spurring an increased interest in increased mergers and acquisition activities, soon after the passage of the Interstate Banking act of 1994.
Shareholders return was based o dividends and market appreciation was largely dependent on bank’s earnings per share growth. To achieve sustained growth on earnings a well of revenue growth needs to be found and impeccable credit control system. For many banks the sources of growth will be based on obtaining new markets simply through mergers and acquisition the larger regional banks built their franchises gradually through a complex combination of internal growth and mergers and acquisition. (Tayisya, np)
There are many reasons for the continuing treat of mergers and acquiring activities. Firstly that the selling bank might feel that their organization might potentially be reaching the highest return on equity and assets. Secondly, the prospects of facing and managing another round of credit control problems. Thirdly, the diminishing revenue opportunities when an economy is slowing down followed by the unwillingness or inability to keep abreast with technological changes. Fourthly, the prospects of cost minimization and entry to an attractive and lucrative market. The buying of a bank’s management will no longer be restricted by interstate legislation to achieve critical mass.
The infamous nationwide baking bill will have an adverse effect on merger activity that till date practice interstate banking laws. And finally the willingness of many close to retirement CEO’s to leave with a considerable amount of wealth to their name from the takeover premium earned. For the remainder of this decade bank consolidation will follow three basic phases. Firstly, the banks will look to stockpile investors, as the trend of smaller banks selling out to larger banks, while in the process achieving wholesome premiums for shareholders and a more than competitive future for their banks.
Keeping in mind the radical changes and expenses required to revamp retail banking ad anticipating the slow level of revenue growth, management should fathom the benefits of their shareholders acquiring high premiums for their equity and conversion of their shares into on regular tax-free basis into a stronger , technologically equipped banking firm, which can acquire market leader status. When management recognizes that the higher acquisition premiums and steady earnings per share growth and many other profit ratios have spiked may result in an increased number of banking marriages.
The second phase will be dominant by a fall in premiums paint to acquirers showing simply that selling companies missed the marker while in turn diminishing the franchise value of the bank. The third and last stage that can be experienced could result in a round of mammoth mergers, which are going to amalgamate the nation’s top regional banks that are considered money center banks.
While stockholders might only gain limited benefits from there combinations, the dominance of these institutions could result in huge capital gains. The need to acquire capital may decline as banks leave the risk filled capital intensive business which including lending to corporations favoring non-interest-intensive business, which eventually don’t require much allocation of capital. (Tayisya, n.p.)
The economic consequences of bank mergers cannot be neglected. Firstly the consolidation trend in the financial sector can greatly impact the stock prices. Regional and money center banking indexes in the S&P 500 index rose by 51 percent and 57 percent respectively, compared to the return of only 34 percent. In spite of all the boom and increase in the earnings of banks with the increase in stock prices, the focus of the industry must rely on efficiency. In the past years mergers have resulted I a considerable amount of job losses.
In accumulation to the increase in wealth and unemployment creation these mergers and acquisitions are likely going to have more business and economic effects on other small banks and consumers specifically in markets where the competition has been reduced due to mergers and acquisitions. In these particular markets, rates of deposits are likely going to be lower than what it could have been in more competitive markets, which will result in a higher lending rate for smaller business. And eventually consumer credit cards are rates will decline further because for increasing competition for national card issuers both within and outside the banking financial industry.
Mergers firstly do not effectively and efficiently reduce the whole competitive process; conversely mergers can pose a risk for shareholders and not customers. Although the public benefit of mergers are often discussed in the context of potential economies of scale and economies of scope and this is not the only method in which mergers contribute to public benefit. Another important clause to consider while pondering over these disappointing failures is that management’s inability to carry out potential and rational savings pattern of paying premiums on the take-over price.
Therefore it is imperative to have good management to reap the benefits of a successful merger and not pass on any sort of inefficiency to the public. The trend from an increased activity in mergers and acquisition will continue, driven by the profit motive and the pressure to improve stockholders value. The winners in this game will be those banks that can influence their networks of distribution and provide the greatest number of products and services across the largest consumer baser keeping quality high in an efficient manner.
This consolidation trend will provide mass in much business. And many small emerging banks may not posses the competence to survive in the competitive banking environment. This will eventually lead to erosion in the value of their franchise due to diminishing critical mass, inadequate and out-dated technological resources, limited product range and the ever burdening regulations. (Lee, n.p.)
Most mergers will be carried out internally, making room for greater operation efficiency. There will also be mergers with adjacent markets allowing a diversification of credit risks over all economic regions and more distribution outlets for all lines of products and services. When banks will purchase non banking companies such as brokerage houses, mutual funds, mortgage banks and other credit card companies will contribute to generating fee income and provide the much needed economies of scale.
This will also result in some mega mergers like the Bank of America’s acquisition with the Security Pacific and Continental, as well as mergers between equal standing banks may link some regional franchises like the Bank of New York with the Bank of Boston. For many banks mergers will create an increased market power. The benefits of such mergers may be an increased line of products and services with better service and efficiency if managed correctly by managers. Complex studies of cost structures and premium paid during acquisitions is required and expenses are involved in changing the product mix of goods and services without a great increase in costs then the chances of it surviving are much better.
As many people have observed that the banking industry is forever changing, with technology replacing humans and most of the borrowing and lending activities at a decline, it is easy to understand why mergers are required to carry out such changes for example mergers might be able to get rid of inefficient managers ad be replaced by those who can carry out the shift of product mix more easily. The rapid change in the merging of banks trends are drawing a lot of attention of the general public and those that posses the knowledge of economics, there is still a lot to learn why banks find the urge to merge and what does it exactly mean, economic pondering has only be able to come up with general conclusions.
The trends of merged banks in recent past have been not to increase efficiency by reducing cost per unit. The fact that risk reducing, risk increasing and market power has not been investigated to the core. Available literature depicts that these do not play an important role in merger and acquisition phenomenon. And lastly whether banks merge to experience a shift in product mix remain an intriguing question for many.
Many fear the prospect of less available banking officers is less daunting to Fleet Boston’s clientele that have totally diversified their banking relationships to prevent a total over dependence. There is a strong likelihood there will be a continuation in the trend of giant bank mergers which will definitely raise corporate caution levels. The consolidation process in the U.S. banking sector since the early eighties has had a detrimental effect on the structure of the industry.
There are about 3500 mergers taken place in the past decade under the scrutiny involving acquisition of over $3.1 trillion in assets. Acquisitions took place in all states, but the echelon of activity mottled greatly by state. The huge preponderance of mergers involved an objective that operated in a single state and an acquirer with at minimum one office in that state. (Lee, n.p.)
Berger, Allen . “9425.pdf.” Financial Institution Center. 2005. Financial Institution Center. 21 May 2008 <http://fic.wharton.upenn.edu/fic/papers/94/9425.pdf>.
Craig, Ben. “200802dkp_b_.pdf.” Deutsche Bundesbank. February 2008. Banking and Financial Studies. 21 May 2008 <http://www.bundesbank.de/download/bankenaufsicht/dkp/200802dkp_b_.pdf>.
Dinger, Valeriya . “Craig_Dinger.pdf.” FDIC: Fedral Deposit Insurance Corporation. nov 2007. Fedral reserve Bank . 21 May 2008 <http://www.fdic.gov/bank/analytical/cfr/Craig_Dinger.pdf>.
Gómez, Leonardo. “PAPER12.pdf.” nd. Univercity of Brazil. 21 May 2008 <http://www.vito.be/erscp2005/documents/papers/PAPER013.PDF>.
Lee, Cassey . “2007-05.” ICSEAD Homepage. march 2007. Nottingham University Business School. 21 May 2008 <http://www.icsead.or.jp/7publication/workingpp/wp2007/2007-05.pdf>.
Purkayastha, Saptarshi . “Saptarshi Purkayastha.pdf.” Indian Institute of Management. 2005. The ICFAI Institute for Management Teachers. 21 May 2008 <http://iimk.ac.in/GCabstract/Saptarshi%20Purkayastha.pdf>.
Shepetko, Tayisya. “body.pdf.” EEEC. 2004. National Univercity. 21 May 2008 <http://www.eerc.kiev.ua/research/matheses/2004/Shepetko_Tayisiya/body.pdf>.