Tobacco Industry is Oligopoly

An oligopoly is the market structure of a few large firms dominates in the industry. The number of seller or firm in an oligopoly market is very few but there are many buyers in the market. The market concentration of oligopolists is very high although it is just dominates by a few firm. Some industry is producing differentiated products or homogeneous products. Homogeneous products are goods that with no preferences; differentiated products are goods with a lot of variety and with preferences. In a simple way, homogeneous are products that are close substitute to each other and is an identical product. The example of homogeneous products including cement and steel. The example of differentiated products including automobiles, cigarettes and soft drinks.

Tobacco industry is an example of oligopoly market. There are 3 major companies dominant the tobacco market in Malaysia, they are British American Tobacco (M) Bhd (BAT), JT International Bhd (JTI) and Philip Morris. The total market share of the stated 3companies is about 91% in Malaysia. As can see, they are holding a huge market share in Malaysia. BAT Malaysia hold the highest market share of about 61% and 18% and 21% respectively hold by JTI and PMI (The Star, 2008). Although they are selling the same products, cigarette, but cigarette with different taste and feeling from different brand name and companies differentiated their products with each other. So cigarette is a differentiated product. Apart from that, UK also proven through this article (https://www.keynote.co.uk/market-intelligence/view/product/10494/cigarettes-%26-tobacco).

Most of the firms under oligopoly have almost blocked the entry for new entrants. This is due to three reasons, economics of scale, government legal barriers and substantial investment. The barrier to enter the tobacco industry in Malaysia is very high. As the British American Tobacco Malaysia is part of the British American Tobacco group (BAT Malaysia, 2013). Which BAT is the world’s most international group and the second largest tobacco market group with global market share. The same tobacco industry competitors like JTI and PMI have been around over the times, therefore it makes difficulty for the new entrant to survive in the tobacco industry in Malaysia. It is almost blocked. Therefore, BAT Malaysia is taking the advantages of economics of scale. They have the advanced technologies over the year. Economics of scale is about when increasing the scale of production leads to a lower long-run cost per unit of output. Which means when the average cost is falling (Curran, 2007).

Economies of scale

This is applicable in the following article  (http://lcchong.files.wordpress.com/2011/06/bat-05312011.pdf). Besides that, the tobacco industry in Malaysia is under the interventions of government. Therefore, article (http://tobaccocontrol.bmj.com/content/13/suppl_2/ii43.full), the government of Malaysia had taken over some control of the tobacco industry. Although most of the oligopoly differentiated their products with strong investment in advertisements, but in the year of 2005, Health Minister Datuk Dr Chua Soi Lek announced that all cigarette advertisements and billboards had to be removed. So advertisements is no longer works in the tobacco industry. This happen same in America according to this article

 (http://althistory.wikia.com/wiki/No_Cigarette_Advertising_Ban_in_America). While in US is according to this article (http://www.smokernewsworld.com/ban-on-cigarette-advertising/)

Apart from that, the barriers to entry the tobacco industry locally is initially low. This is proven in this article, 




(http://webcache.googleusercontent.com/search?q=cache:rATfaomaKAMJ:www.personal.psu.edu/ajk5087/Industry%2520Analysis.doc+low+barriers+of+tobacco+industry+locally&cd=1&hl=en&ct=clnk&gl=my).

            The tobacco industries in Malaysia are non-collusive oligopoly or non-price competition. This is because the each tobacco companies will perceives that its rivals will easily and quickly match any price reduction. Besides that, the government tax of cigarette is always increasing and had never decline. in order for government to reduce the demand of cigarette, the most effective ways is to increase the tax (The Star, 2011). This also applicable in the tobacco industry in Pakistan followed by the article (http://www.euromonitor.com/tobacco-in-pakistan/report).

Few days ago, BAT Malaysia had announced the price of the cigarette hold by the companies increase by 3% due to the inflationary pressure and rising input costs (The Star, 2013). They are interdependence oligopoly. As BAT Malaysia is holding the biggest share in the market, it is playing the role as a price leadership. Price leadership can be explained of the firm that dominates in the market and sets the price that others will follow. Which means that, when BAT Malaysia increases the price of the cigarette, it wills bring awareness to another two firms. JTI and PMI will be responding to the increases price of BAT Malaysia in the following days. This also applicable in Altria Group through this article (http://www.marketwatch.com/story/altria-first-tobacco-maker-to-raise-prices-in-2012-2012-06-14)

Cigarette Brands	Price in 2012	Price in 2013
DUNHILL	RM10.20	RM10.50
KENT	RM10.20	RM10.50
PETER STUYVESANT	RM8.70	RM9.00
ROTHMANS INTERNATIONAL	RM10.60	RM10.90.
BENSON & HEDGES	RM10.20	RM10.50
LUCKY STRIKE PLAIN	RM10.60	RM10.90

                                                                                    (The Star, 2013)

Kinked Demand Curve

A non-collusive oligopoly of tobacco industry in Malaysia is facing a kinked demand curve. Kinked demand curve is being explained as the best prediction of the behavior of an oligopolists and a kinked demand curve facing by oligopolists that assumes the rivals will match a price decrease but ignore the price increase (Tucker, 2011). The demand in assumption 1 is relatively elastic. Besides that, the demand curve is relatively inelastic in the second assumption. There are two assumptions when the BAT Malaysia made changes to its cigarette price. In this case, BAT Malaysia had increased all of their cigarette products by 3%. Will the other competitors followed? Back to the year of 2012, due to the taxes increase by the government, BAT Malaysia had announced their increasing price of 20sen. However, JTI and PMI remains unchanged of their cigarette brand price, for more details it can be found in this article (http://www.theedgemalaysia.com/business-news/223576-jti-and-philip-morris-maintain-cigarette-prices.html). According to the kinked demand curve, PMI and JTI remain their prices unchanged in the year 2012 this is because PMI and JTI can gain customer from BAT Malaysia.

Inelastic Demand

The demand for cigarettes is inelastic. This is because no matter how much the price of the cigarettes increase, there will still be buyers in the market. Due to cigarettes can make the consumer addicted, they can’t stop purchasing cigarettes when they can’t get rid of the addiction to the cigarettes. On an average of price rises 10%, the demand is expected to be reduce by 4% in high income countries and 8% in low and middle countries. In Malaysia, the estimated cigarette price elasticity is about 0.38. This means that when 10% increase in the price of cigarette, the demand is tend to be decline in 3.8% (The Star, 2011). This means that change in the price bring lower effect to the changes in the quantity demanded and this resulting in a steep curve. 

For assumptions, the increasing of the raw materials in BAT Malaysia had pushed the marginal cost from MC1 to MC2.  From the diagram, we can see that not a necessary lead to a higher price of the cigarette that MC2 cuts the MR curve at the same output (Q1). The gap between a and b where MR=MC the profit is being maximized. If the price MC of BAT Malaysia is lies between the point a and b, the profit maximizing price and output will be P1 and Q1. According to the theory of kinked demand curve, the price will be sticking to the market and the firms will concentrate more on non-price competition to earn revenues (Tutors2u, n.d.).

Supernormal Profit

The tobacco industry in Malaysia is earning supernormal profits no matter long-run or short-run. This is because the barrier is almost blocks the new entrants to entry. In oligopoly, the key feature of earning supernormal profits by oligopoly is that a firm must consider the reaction of other firms to its own actions. As a result, the kinked demand curve theory predicts that price and output levels may be relatively stable in an oligopolistic market. When BAT Malaysia increased their price in 2013 by 3%, PMI and JTI is about to take proper action towards this.

This is also applicable in US through this article (http://www.parliament.nsw.gov.au/prod/parlment/hansart.nsf/V3Key/LC20001012031)

By and large, we can conclude that the tobacco industry is earning supernormal profit due to they are an oligopoly. They have the power to set the prices and others will always aware to their competitor’s action due to they are interdependence. The barriers to entry this industry in Malaysia is very high. In a summary, smoking is a bad habits and it can causes a lot of cancer and disease and this had proven for centuries. If you love your family, please quit smoking now to have a better life.  

References

BAT Malaysia (n.d.). Who we are. [ONLINE] Available at: http://www.batmalaysia.com/group/sites/BAT_7RYJ8N.nsf/vwPagesWebLive/DO7SUK8D?opendocument&SKN=1. [Last Accessed 05 June 2013].

Curran, J. (2007) Taking the Fear Out of Economics [online]. 2nd ed. UK: Thomson. [Accessed 06 June 2013].

“Delay in 14-stick cigarette pack ban a risky move”, The Star, 01 Jun.

Tucker, I.B. (2011) Economics For Today [online]. 7th ed. Canada: Nelson Education. [Accessed 05 June 2013].

kinked demand curve under oligopoly. (n.d.) [ONLINE] Available at: http://www.tutor2u.net/economics/content/topics/monopoly/kinked_demand.htm. [Last Accessed 04 June 2013].

 “Kjeldsen-kragh, S. (2002) International Economics [online]. Denmark: Copenhagen Business School Press. [Accessed 06 June 2013].

Tan, Y and Adnan, H. 2008, “Cigarette price war”, The Star, 11 Nov.

Way to snuff out habit”. 2011, The Star, 04 October