The Herfindahl Index or Concentration index is a measure of the size of the firm in relation to the industry and an indicator of the amount of competition among them. Higher values of Herfindahl index generally indicates a decrease in competition and an increased market power, whereas lower values of Herfindahl index indicate the opposite.
The Herfindahl index can be calculated using the formula below; = Where, Si- The market share of firm ‘i’ in the market N- The number of firms The above calculated value of H can be inferred using the table1 below; Herfindahl index 0-1000 1000-1800 Above 1800 Competitive, but element of oligopoly Oligopoly/Monopoly Nature of Market Highly Competitive 3 MARKET STRUCTURE We have followed the below steps to calculate the market share of each company; ? The Total Revenue from operations for the year 2012-13 is collected from the annual report of the respective companies ?
The market share percentage is arrived based on the Total Revenue of the particular company to the total revenue of the sample selected for analysis Company INDIAN MARKET Larsen & Toubro 54. 75 3308 Market Share (%) Herfindahl Index 1 Discussed during the Contact class Assignment # 03 – Microeconomics Page 1 of 5 Company Punj Lloyd Lanco Infratech Ltd NCC IVRCL Simplex Gammon India HCC Market Share (%) 8. 80 8. 73 5. 65 6. 39 5. 97 5. 72 3. 99 Herfindahl Index.
MIDDLE EAST MARKET Larsen & Toubro Galfar Engineering Others 25. 60 56. 90 17. 50 4199 3. 1 Indian Market : substantial increase in the number of contractors and builders : demand exceeds supply by a large margin : high working capital requirements, high financial charges, high taxation : suppliers- low (due to rapid increase in suppliers) Customers- low (lack of adequate infrastructure) : Very high across segments Supply Demand Entry Barrier Bargaining Power Competition 3. 2 Middle Eastern Market.
Supply : substantial increase in the number of contractors and builders, however most of the major projects are run by international contractors Demand : demand not exceeds supply, favorable taxation and stable economic conditions, low financial charges Entry Barrier : high working capital requirements, visa/work permit requirement, labor rules and regulations Bargaining Power : Suppliers- high (due to monopoly of the market) Customers- low (due to adequate infrastructure) Competition : High across segments Assignment # 03 – Microeconomics Page 2 of 5 4 4. 1
CHANLLENGES Major Cost- Fixed and Variable Primarily, the L&T construction’s fixed cost constitutes salary and benefits for employees, Financing charges (interest, Over Draft & LC charges, etc. ), Leasing of apartments and/or office spaces, other overhead expenses, depreciation of P&M, Utility bills, Taxes, Transportation Expenses, Tendering cost, Visa Charges, Statutory requirement of employing locals, Customs duty etc. ; whereas the variable costs elements are mainly Labour charges, cost of material, taxes/duties on materials, service taxes, variability in power and fuel charges etc.
Owing to the higher fixed cost (due to centralization of departments) than the variable cost in L&T construction, the breakeven point is typically at a much higher level of output, and the marginal profit is also much higher. This affects the financial structure of L&T construction as well as its pricing and profits 4. 2 Pricing Strategies The three main strategies followed in setting price are; Cost-based pricing: price is determined by adding a profit element on top of the cost of making the product. Customer-based pricing: where prices are determined by what a firm believes customers will be prepared to pay.
Competitor-based pricing: where competitor prices are the main influence on the price set Considering the substantially high market share of L&T, we normally follow the Cost based pricing. However, in order to restrict the competition, in some cases, L&T adopts Competitor based pricing too. One of the innovative strategies offered by L&T is the adoption of EPC (Engineering, Procurement & Construction) and/or Turn key projects, where in the clients will get the facility at the end of the project period for the given price, and L&T will take care of the all process in between.
A modified version of the same, known as Design & Build, wherein the concepts designs are developed to meet the requirements of the client, then procure and construct the facility by L&T. L&T also operate some projects under BOT (Build Operate Transfer), BOOT (Build Own Operate Transfer) or/and BOLT (Build Operate Lease Transfer); wherein a part of the project funding also will be taken care by the contractor along with the construction. With the growing number of competitors in Indian market, L&T construction is moving towards competitor based pricing.
Now these days, they are more inclined towards “Going-rate” pricing –i. e. setting a price that is in line with the prices charged by direct competitors. An advantage of using competitive pricing is that selling prices should be in line with rivals, so price should not be a competitive disadvantage. And hence, L&T construction can edge out its competitor by other factors, such as quality, timely completion & safety etc. L&T construction is also using non-price methods –e. g. providing distinct customer service or better availability – to ward off any threat from the competitors.
Assignment # 03 – Microeconomics Page 3 of 5 4. 3 4. 3. 1 Impacts on Potential Profits Challenges due to high cost/ Market structure/ Economic downturns L&T construction’s potential profit taking a hit because of high input cost (increasing cost of construction material & site labour), changing global and Indian market structure (increase in the number of competitors affecting market share) and the recent downturns in Indian economy. 4. 3. 1. 1 Challenges due to high cost Potential profit has a deep impact on account of rising input cost.
Main raw materials in the construction business (Steel & cement) have seen an exponential rise in their prices, and so the labour cost. Labour and material cost combined constitutes approximately —-% of total construction cost. Thus, even a little increase in their prices has a big impact on overall construction cost, resulting in a reduced profit margin. Since a typical construction project runs over a period of three years, there would be a huge increase in material cost than originally conceived at the time of tendering. This brings down the planned profit margin for a project.
4. 3. 1. 2 Challenges due to Market structure The risk of entry by competitors increases the industry's capacity, starts a greater competition for market share, and generally lowers current pricing. Extreme rivalry among competing firms poses a strong threat to profitability to all firms within the industry. The bargaining power of buyers can reduce the profits within an industry by lower the prices. At present, since L&T construction is having a major share in domestic market, it got a good number of loyal clientele (like, Maruti Suzuki, Cognizant, Infosys, ITC, and Delhi Metro etc.
) from where it gets order in bulk. So, these large quantity purchasers drive down prices because of their purchasing power, and thus it impacts the profit margin of the company. Otherwise, if the company doesn’t oblige to these clients, it risks losing these large quantity sales to a competitor. Similarly, since the main raw materials for construction (Steel & cement) comes from a very few suppliers, the bargaining power of suppliers reduces L&T construction’s profitability by increasing costs to the company.
4. 3. 1. 3 Challenges due to economic downturns After recording a spectacular growth of over 12%, more than the country’s GDP in the past halfdecade, the Indian construction sector all of a sudden lost stream in last fiscal largely due to global financial turmoil. Not just this, the turmoil tremors created multiplier impact across sectors including steel, cement, power, petroleum, aluminum, IT and ports, besides badly Bruising the Indian economy.
Hence, in order to safeguard shareholder’s interest and maintain the profitability, Larsen & Toubro construction is concentrating its operation in foreign economic markets (especially middle-east & Africa region) to take advantage of potential profit opportunities in developed or emerging economies. Assignment # 03 – Microeconomics Page 4 of 5 Currently, the global economy is in slowdown mode amidst deepening credit crunch and upsetting developmental targets of economies across the world.
In the prevailing scenario, infrastructure remains a top priority for addressing developmental gaps as it is considered omnipotent with potentials of lifting economies out of the financial turmoil. The governments around the world are pumping money to generate demands for goods and services by creating jobs through higher spending into physical and social infrastructure. Likewise, the Indian government on its part is not lagging behind on this score and has taken concrete steps to revive the sector to regain its past glory.
A few sectors such as telecom, urban infrastructure, railways which are also generating large share of construction activities have not been affected badly. These segments have registered a noticeable growth in project orders from centre, states, and local firms. 5 REFERENCES ? www. equitymaster. com, Construction sector analysis report dated 06 Nov 2012 ? http://www. constructionweekonline. in/article-6640indias_top_10_infrastructure_companies/1/ ? ‘The Herfindahal-Hirschman Index’ by Sterpen A Rhoades of the boards division of Research and statistic, March 1993 Assignment # 03 – Microeconomics Page 5 of 5