Monopolistic competition is one of the four major types of market structures along side perfect competition, oligopoly, and monopoly. It is characterized by the presence of numerous firms operating within a particular market or industry offering competing products that are somewhat similar but have significant levels of differentiation.
This market structure has its pros and cons. Understanding it can bring forth an in-depth understanding of relevant markets, especially their qualitative size, the intensity of the competition or industry rivalries, and the barriers to entry, among others.
The Characteristics of Monopolistic Competition
• Numerous Firms: Similar to perfect competition, which is another type of market structure, one of the key characteristics of monopolistic competition is that there are a large number of firms competing with each other for the same general target market.
• High Product Differentiation: However, unlike the absence of differentiation or the prevalence of product homogeneity in a perfect competition structure, this market structure has similar albeit considerably differentiated products. These products are not perfect substitutes because they have different selling points such as quality, features, and pricing intended for a well-defined target market.
• General and Specific Target Market: The target market is broad because of the presence of a large number of consumers. Firms differentiate either to appeal to the greater market or specific market segments. The market fundamentally has a variety of somewhat similar but differentiated products aimed at different consumer preferences.
• Free Entry and Exit Barriers: Furthermore, there are few barriers to both entry and exit. Threats from new entrants are high. Markets or industries under this structure have seen several firms emerging and disappearing from time to time.
• High Intensity of Competition: Rivalries or competition in this market are intense because of the size of the target market, as well as the low entry barriers. Some of the sources of competitive advantage include innovation and technology, production efficiency, differentiation, and cost leadership, among others.
• Price Setter Power: The prices of products are dictated by the interplay between the forces of supply and demand. However, because of the intensity of competition and the number of firms, as well as the importance of differentiation, established and even capable firms are price setters rather than price takers.
To put in context the aforementioned characteristics, consider the smartphone market as a prime example. Note that this market has numerous producers or firms from different parts of the world. Furthermore, these firms target a general market now known as smartphone users.
In terms of demographics and psychographics, the target market is diverse. Different firms offer differentiated products to appeal to specific market segments. Apple appeal to a sizeable mainstream market segment composed of new and repeat consumers who do not mind the premium pricing strategy set for iPhone products.
Some firms appeal to price-sensitive market segments. This is true for Chinese smartphone manufacturers. Other firms appeal to different segments at once. Samsung offers a selection of smartphones for power users, mid-range users, and budget users.
The smartphone market essentially sells smartphone devices with similar call, messaging, internet browsing, and photo taking and video recording functionalities. However, these products are differentiated in terms of pricing, quality, specific features, and added specifications to appeal to specific segments of the larger target market.