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Technology and Market Structure: Theory and History.

By John Sutton.

Cambridge, MA: MIT Press, 1998. Pp. xv, 676. $55.00.

John Sutton's study of technological change is an ambitious, rich, and important work. Changing focus from his 1991 book on advertising and market structure, Sutton's attention here is on technological change as a determinant of market structure. The book's contribution is a fresh application of game theory to the interactions of technological change, economic history, and market outcomes. The undertaking even requires 140 pages of mathematical and descriptive appendices!

The book is organized into three parts. Part One presents Sutton's study of market entry utilizing a stage-game theory. Entry is analyzed utilizing an escalation parameter alpha ([alpha]). Alpha is a ratio of the profitability for a new entrant relative to current expenditures on research and development (R&D) by existing firms or "a measure of the extent to which a firm that outspends its rivals on R&D can thereby raise [demand]" (p. 63).

Sutton uses a simple lottery analogy to show how [alpha] can lead to structural insights. The profit earned by a high R&D spending firm may "be diluted indefinitely by the presence of a sufficiently large number of low-spending rivals" (p. 71). As with a lottery ticket, the expected payoff in such instances can be too small to warrant action. In low [alpha] industries, "a high entrant cannot achieve a profit exceeding some fixed proportion of current industry sales independently of the number of low-spending rivals" (p. 71). The opposite is the case in high-[alpha] industries, which is illustrated by Sutton's history of the color film industry.

The effectiveness of R&D escalation, and therefore the value of alpha, depends on two factors: (i) the effectiveness of R&D spending on increasing demand (willingness to pay). If R&D spending is ineffective in raising demand, R&D intensity is necessarily low, and (ii) the strength of linkages between different R&D "trajectories" and their associated submarkets. For industries with high R&D/sales ratio, R&D effectiveness should be high. Whether this leads to a relatively high level of concentration depends on the strength of the linkages between submarkets.

Key also is Sutton's bounds approach to analyzing the link between technology and market structure. Economics is inherently the study of tradeoffs. For Sutton, the bounds tradeoff involves giving up specificity of results (equilibrium points) for a fuzzy "set of outcomes that can be supported as an equilibrium" (p. 7).

In Part Two, actual entry becomes the focus and dynamic game theory is used to extend Sutton's methodology beyond traditional results. "The central idea that emerges is that, under some very weak restrictions on the form of entry process, it is possible to place a restriction on the degree of inequality of size distribution of firms within each industry. This restriction depends only on the fact that there are many independent submarkets, and not on the details of what goes on within each submarket" (p. 20).

In Part Three, specific markets that are R&D-intensive are examined, including semiconductors, VCRs, and mainframe computers. An extended example is made of manufacturing commercial aircraft. This industry adopted a "dominant design" in the 1930s with the creation of the Douglas DC-1 and DC-3. The next 60 years were to be a period of escalation of R&D expenditure and industry shakeout as the future trajectory of technology was set. Sutton shows that neither unit-size effects nor learning-by-doing satisfactorily explains the (predicted) emergence of duopoly in 2000. Growth in demand has kept unit size from being critical while the uneven nature of aircraft purchasing makes learning-by-doing of little significance. Rather, the rising concentration in this industry is best explained via Sutton's R&D escalation mechanism. As industry R&D/sales ratios rose, profitability fell and fewer and fewer firms were able to survive.

It is difficult to survey adequately the richness of Sutton's analysis. He has established a benchmark for research in the impact of technological change on market structure. His modes of analysis should have wide application as the pace of technological changes continues.
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Title Annotation:Review
Author:Vahaly, John
Publication:Southern Economic Journal
Article Type:Book Review
Geographic Code:1USA
Date:Oct 1, 2000
Words:678
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