The Structure-Conduct-Performance (S-C-P) paradigm of strategy assumes market structure would determine firm conduct which would determine performance. This is a paradigm that is foundational to industrial organization economics, consistent with the positional view of strategy, as opposed to the resource-based view of strategy.
Barney on SCP (Barney, 2007, pp 54-57)
In the 1930s, a group of economists began developing an approach for understanding the relationships among a firm's environment, its behavior, and performance. The original objective of this work was to describe conditions under which perfect-competition dynamics would not develop in an industry. Understanding when perfect- competition dynamics were not developing assisted government regulators in isolating those industries in which competition-enhancing regulations should be implemented.
The theoretical framework that developed out of this effort became known as the structure-conduct-performance model (SCP). The term structure in this model refers to industry structure, measured by such factors as the number of competitors in an industry, the heterogeneity of products, and the cost of entry and exit. Conduct refers to specific firm actions in an industry, including price taking, product differentiation, tacit collusion, and exploitation of market power. Performance in the S-C-P model has two meanings: the performance of individual firms and the performance of the economy as a whole. The structure-conduct-performance model is summarized in Figure 3.1.
The logic that links industry structure to conduct and performance is well known. Attributes of the industry structure within which a firm operates define the range of options and constraints facing a firm. In some industries, firms have very few options and face many constraints. Firms in these industries generate, at best, returns that just cover their cost of capital in the long run, and social welfare (as traditionally defined in economics) is maximized. In this setting, industry structure completely determines both firm conduct and long-run firm performance (normal).
In other less competitive industries, firms face fewer constraints and a greater range of conduct options. Some of these options may enable firms to obtain competitive advantages. Even when firms have more conduct options, industry structure still constrains the range of those options. Also, other attributes of industry structure- including barriers to entry-determine how long firms in an industry will be able to sustain their advantages. Without barriers to entry, any competitive advantages by firms in an industry will be quickly competed away by new entrants. Thus, even in this case, industry structure still has an important effect on firm conduct and firm performance even though firms in these industries can sometimes have competitive advantages.
One way of describing the competitive structure of different industries is presented in Table 3.1. As shown in this table, industries can be described as perfectly competitive, monopolistically competitive, oligopolistic, or monopolistic.
Industries are perfectly competitive when there are large numbers of competing firms, products being sold are homogeneous with respect to cost and product attributes, and entry and exit are very low-cost. Examples of such perfectly competitive industries include the spot market for crude oil. As is well known, firms operating in perfectly competitive industries can act only as price takers. A firm is a price taker when it responds to changes in industry supply or demand by adjusting prices rather than attempting to influence the level of supply or demand. Price-taking firms can expect to gain only competitive parity.
Other industries can be described as monopolistically competitive. In these industries, firms carve out market niches within which they act as quasi-monopolists. However, these monopoly positions are always threatened by the competitive actions of other firms in the industry. In monopolistically competitive industries, there are large numbers of competing firms and low-cost entry and exit into and out of the industry. However, unlike the case of perfect competition, products in these industries are not homogeneous with respect to costs or product attributes. Rather, firms in this type of industry are successfully implementing product differentiation strategies-strategies that will be discussed in more detail in Chapter 7. Examples of monopolistically competitive industries include toothpaste, shampoo, golf balls, and automobiles. Firms in such industries have a variety of conduct options and can gain competitive advantages.
Still other industries can be described as oligopolies. Oligopolies are characterized by a small number of competing firms, by either homogeneous or heterogeneous products, and by costly entry and exit. Examples of oligopolistic industries include the U.S. automobile and steel industries in the 1950s and the U.S. breakfast cereal market today. Currently, the top four producers of breakfast cereal account for about 90 percent of the breakfast cereal sold in the United States, and the top eight account for almost 100 percent of the breakfast cereal sold in the United States. Firms in such industries also face a variety of conduct options, including tacit collusion, a strategy described in more detail in Chapter 10. Firms in oligopolistic industries can earn significant economic profits.
Finally, a few industries can be described as monopolistic. Monopoly industries consist of only a single firm. Entry into this type of industry is very costly. There are few examples of purely monopolistic industries. However, one industry that comes close to being a monopoly is the personal computer operating systems industry-an industry almost completely dominated by Microsoft. One of the critical conduct options facing firms in this kind of industry is the use of market power to set prices that generate significant economic value.
The regulatory implications of the S-C-P paradigm depend on the level of social welfare associated with each of the types of competition presented in Table 3.1. Social welfare is maximized in perfectly competitive industries, it is somewhat lower in monopolistically competitive industries, it is somewhat lower still in oligopolies, and it is very low in monopolies. Thus, the information in Table 3.1 can be used to identify when and how competition in an industry varies from the perfectly competitive ideal. Once identified remedies that increase the level of competitiveness in an industry can be instituted.
Strategy researchers have turned the traditional objectives of the S-C-P model upside down. Instead of seeking ways to increase the competitiveness of industries, strategy researchers have used the S-C-P model as a way to describe the attributes of an industry that make it less than perfectly competitive, and thus help firms find ways to obtain competitive advantages.