ECO 501 Economics for Business Unit Coordinator: Dr James Nayagam

Assignment 1

Due: 20th February 2010

The Railway Technology Companies in Malaysia An Oligopoly Market

Student ID: Mr RALPH YEW (10166320)

TABLE OF CONTENTS

I. II. III. IV. V. VI. VII. VIII. IX. X. XI.

Introduction Railway Technology Companies in Malaysia- an Oligopoly The Good vs Bad of Oligopoly Analysis Of The Malaysias Railway Technology Players Porters Five Forces of Competitive Analysis Two Main Competitive Force Identified in AnsaldoSTS Game Theory Strategic Plan of Action for AnsaldoSTS Conclusion References Bibliography

3 4 6 9 13 16 17 19 21 22 23

The Railway Technology Companies in Malaysia An Oligopoly Market I. Introduction

Malaysian railway industry is a government entity which is under the Malaysian Railway ( KTMB). The supplier and vendor for the railway technology can be categorized under the oligopoly market. An oligopoly is a market dominated by a small number of strategically interdependent firms. In such a market, each firm recognizes its strategic interdependence with others. The strategic interdependence requires that only a few firms dominate the market

The strategic interdependence can becomes weaker as the market becomes smaller, like the case of Malaysian railway. Traditionally, the suppliers and players will create strategic barriers designed to keep out potential new competitors. Such example are like requiring the product to have type-approval from Malaysian Railway or the product be tested for tropicalised condition if there are qualify for the use of Malaysia railway market. The effort required considerable time and investment. Some other form of legal barriers may include patents and copyrights, Government legislation.

Oligopoly present a great challenge to business economist at times and one approach is the game theory. Game theory gave good insights into oligopoly behavior. In Game theory, a players strategy must take account of the strategies followed by other players. Game theory analyzes oligopoly decisions as if they were games. In some games, one or more players may not have a dominant strategy. Other game may have two players will have a Nash equilibrium as long as at least one player has a dominant strategy. When neither player has a dominant strategy, then we need a more sophisticated analysis to predict an outcome to the game. The simplest form of

cooperation is explicit collusion. Collusion is when the oligopolists agree in formal or informal to limit competition between themselves.They may set output quotas, fix prices, limit product or development or agree not to poach each others market ( Sloman, Hinde, 2007)

II.

Railway Technology Companies in Malaysia an oligopoly market

I worked for AnsaldoSTS ( formerly Union Switch & Signal ) a multinational company which in 2007 has acquired an established Australian rail system company called Union Switch & Signal. In Malaysia, the company Union Switch & Signal was established in 1998. In Malaysia the railway technology are control by a few major players. They are Siemens Mobility, Invensys, Alstom Transport and AnsaldoSTS. Here for this paper on microeconomics we will look at the analysis of their oligopoly market and examine the key competitive forces affecting our local the rail industry. The oligopoly players are supplying the homogenous product namely the signaling, point machine, wayside equipment and automated train protection to the Malaysian Rail (KTMB). The Malaysian Rail is under our Ministry of Transport is the sole provider for our national public rail transportation and rail cargo transportation in the country. In line with the focus of our Government to further improve our public transportation usage and modernization of our railway track in this country, our Government has embarked on a mission to implement the electrification of double track railway lines spanning from the north section of Padang Besar to Ipoh , stretching to Rawang and continue to the main central station KL Sentral. This has created tremendous opportunity for the few players to position themselves strongly to specify their track equipment to the Malaysian Rail ( KTMB) and to win major rail

contracts that amount to billions of ringgit. Until now it is still dominated by a few of the major European rail companies.

The oligopolists railway companies operating here can collude among the players. The oligopolistic market may be described as a small-enough number of sellers of a homogeneous or differentiated product that each knows the identities and pays careful attention to the actions of competitors in the market. Since I worked for AnsaldoSTS, one of the aggressive global rail players in the market I also kept in touch with the other railway companies. From time to time AnsaldoSTS also use the competitors products for our project. Recently, AnsaldoSTS won a huge railway signaling project for the Malaysians north section of Padang Besar to Ipoh with a length of 330km awarded to us by MMC-Gamuda. AnsaldoSTS is now a dominant rail technology player with the signalling project that span more than 450km of Peninsular Malaysia.

A decision strategy is important in oligopoly because oligopolistic sellers know the identities of their competitors and have some pricing discretion. Possible oligopoly behavior patterns include ignoring competition, price warfare, price rigidity, cartelization, collusion, and price leadership/followership. The price warfare may occur due to unwariness of competitors, or may be initiated deliberately to drive competitors out of business. Sometimes the situation, may lead to extreme price rigidity in oligopoly. Where there are antitrust laws that are vigorously enforced, price leadership or followership will likely emerge as the most common form of oligopoly behavior. The oligopolistic firm which naturally prefers the lowest price in order to maximize profits will tend to be the price leader in the market. The potential price leader may not be the actual price leader in an oligopolistic market.

Although oligopolistic industries tend to be diverse, they also tend to exhibit several behavioral tendencies among them : i) rigid prices ii ) nonprice competition iii )interdependence, iv) collusion and v) mergers and acquisition

III.

The Good versus Bad of Oligopoly

The Good of Oligopoly are firstly the advantage of economies of scale and secondly it is able develops a culture of continuous product innovations.

On advantage of economies of scale, oligopoly company like the railway players can take advantage of economies of scale that reduce prices from its advanced supply chain management, just in time warhousing and and greater production costs. As huge companies, they can "mass produce" at low average cost. Example many modern consumer goods like computers, aircraft, and consumer household products--would be more expensive if produced by a large number of small firms rather than a small number of large firms like the oligopolists.

On the advantage of a culture of innovations, here among the four market structures ( refer Figure 1 : Four Common Market Structure) of perfect competition, monopolistic, oligopoly and monopoly. The oligopoly has the likelyhood to develop product innovations from the advancement of R&D technology, expansion of production capabilities, being able to promote economic growth and better living standards. Oligopoly has both the motivation and the opportunity to pursue innovation. Its motivation arises from access to abundant resources and the interdependent competition.

While the bads of oligopoly is firstly it promotes inequality because concentration of wealth and income. Oligopoly tends to increase the concentration of wealth and

income with single pursuit of profit maximization at the expense of its buyer. The concentration of wealth may sometime be abused to exert influence over the local economy, the society, and the local politics. S Society stands to lose as a result of it it.

Secondly, oligopolists tend to be inefficient in the allocation of resources. The inefficiency for oligopoly is it does not efficiently allocate resources especially with its huge financial resources to undertake mega projects and deals. Like any company deals. with market control, an oligopoly charges a higher price and produces less output than the efficiency benchmark of perfect competition. In real case, oligopoly tends to be the worst efficiency offender in the real world, because perfect competition does not exist, and can go so bad until a time it subject to corrective government regulation.

Figure 1 : Four Common Market Structures

Figure 2 :A Model of Dominant-Firm Price Leadership

In Figure 2, the market demand is Dm. The competitive supply, Sc, is the sum of the marginal cost curves of the competitive company. The locus of the dominant company's demand curve, Dd, is found by subtracting the competitive supply from Dm at each possible price. The dominant company then sets price at P1 to maximize its profits by selling lesser output Q1, while the competitive companies behave as purely competitive price takers to sell quantity (Q2-Q1). This form of oligopolistic market organization is happening, and may continue as long until certain antitrust law is enforced and the dominant company behaves itself. The dominance of the dominant company may break down when one or more of the competitive competitors begins

price experimentation or new product differentiation/in the effort to win and capture a larger share of the market.

IV.

The Malaysias Railway Players Performance for 2008 to 2009

Based on the performance of respective players, for year 2008 we observed that the market leader position achieved by Alstom Transport ranked first place followed by Siemens Mobility, AnsaldoSTS and Invensys. For all the four railway players most of their market share came from European market due to the modernization of their railway infrasturucture and a move to adopt European Rail Traffic Management (ERTMS) standards. As such the rail business is highly profitable. In addition to that between 2008 till 2009 when the financial meldown happen worldwide, most government are injecting financial stimulus package in the form of infrastructure upgrades work resulting in the railway sector experiencing strong growth for all the four players. All the 4 major oligopoly rail technology players operating in Malaysia experienced double digit growth with one of the players Invensys almost doubling its revenue for 2009. I have done a very comprehensive research into the performance of the 4 leading rail technology players with sizable projects in Malaysia. There are Invensys, Siemens Mobility, AnsaldoSTS and Alstom Transport. All of them are established European rail players.

Performance of Rail Technology Players for 2008

Invensys Siemens Mobility AnsaldoSTS Alstom Transport

Order (EURO )mill Revenue ( EURO )mill Operating profit (EURO)mill

493 620 107

5,841 7,842 (230)

1,269 1,105 117

7,371 5,529 395

Source : Annual Report 2009 Siemens, Invensys, ASTS & Alstom Transport

The Rail Technology Players New Order 2008 (EURO )

Invensys Siemens Mobility AnsaldoSTS Alstom Transport

Performance of Rail Technology Players for 2009 ( source Annual Report 2009 Siemens, Invensys, ASTS, Alstom)
Invensys Siemens Mobility AnsaldoSTS Alstom Transport

Order (EURO )mill Revenue ( EURO )mill Operating profit (EURO)mill

1,113 731 154

6,442 6,766 390

1,750 1,170 124

8,100 5,700 408

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The Rail Technology Players New Order 2009 (EURO )

Invensys Siemens Mobility AnsaldoSTS Alstom Transport

Revenue of Rail Technology Players for 2008

Invensys Siemens Mobility AnsaldoSTS Alstom Transport

Revenue ( EURO ) mill

620

7,842

1,105

5,529

Rail Technology Players Revenue for 2008 (EURO )

Invensys Siemens Mobility AnsaldoSTS Alstom Transport

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Revenue of Rail Technology Players for 2009

Invensys Siemens Mobility AnsaldoSTS Alstom Transport

Revenue ( EURO) mill

731

6,766

1,170

5,700

Rail Players Revenue for 2009 (EURO )

Invensys Siemens Mobility AnsaldoSTS Alstom Transport

Operating Profit of Rail Technology Players for 2008

Invensys
Operating profit (EURO) mill

Siemens Mobility

AnsaldoSTS

Alstom Transport

107

(230)

117

395

Rail Technology Players Operating Profit for 2008 (EURO) mill

500 400 300 200 100 0 -100 Invensys -200 -300 Siemens Mobility AnsaldoSTS Alstom Transport Operating profit ( EURO)

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Operating Profit of Rail Technology Players for 2009

Invensys
Operating profit (EURO) mill

Siemens Mobility

AnsaldoSTS

Alstom Transport

154

390

124

408

Rail Technology Players Operating Profit for 2009 (EURO) mill

500 400 300 200 100 0 Invensys Siemens Mobility AnsaldoSTS Alstom Transport Operating profit ( EURO)

V.

Porters Five Forces of Competitive Analysis

The Porter's 5 Forces Competitive Analysis is powerful business strategies tool for understanding where power lies in a business situation. It helps the company to understand both the strength of their current competitive position, and the strength of a position they plan to move into. Refer Figure 3 : Porters Five Forces

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Figure 3 : Porters Five Forces Competitive Analysis

The strongest competitive force or forces determine the profitability of an industry and become the most important to strategy formulation. With a clear understanding of where power lies, the railway technology companies can take fair advantage of a situation of strength, and further improve a situation of weakness, thus avoiding taking wrong steps. Conventionally, the five forces tool is used to identify whether new products or businesses have the potential to be profitable and to understand the balance of power in other situations too.

Porters Five Forces of Competitive Analysis mentioned that there are five important forces that determine competitive power in a situation. The five forces are highlighted here below:

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Firstly, the Supplier Bargaining Power, it potrays how easy it is for suppliers to drive up prices. This is driven by the number of suppliers of each key input, the uniqueness of their product or service, their strength and control over the market, the cost of switching from one to another. The fewer the supplier choices you have, and the more you need suppliers' help, the more stronger the suppliers are. All the railway technology operating here sourced their signallling equipment from Europe and the suppliers delivery lead time is a concern to the buyer.

Secondly, the Buyer Bargaining Power, potraying how easy it is for buyers to drive prices down. Again, this is driven by the number of buyers, the importance of each individual buyer to the business, the cost to them of switching from your products to those of someone else, and so on. In the case of Malaysian Railway ( KTMB) they are the sole buyer, which mean they are often able to dictate certain terms to all the vendors operating in Malaysia. Malaysian Railway will always practice calling for a tender when purchasing the railway equipment.

Thirdly, Competitive Rivalry, explaining the importance the number and capability of the competitors. Meaning if many competitors, thus they may offer equally attractive products and services. Such is the situation that if suppliers and buyers do not get a good deal from you, they will go elsewhere. On this note, because my company AnsaldoSTS has most of its signaling product type-approved for Malaysian Railway thus no-one else can supply this proprietary product, thus AnsaldoSTS have tremendous strength here having monopolized the north section of the signaling with its proprietary Microlok interlocking equipment.

Fourthly, Threat of Substitution, with a few established overseas railway company trying to specify the rail signaling product using overseas consultants to the Malaysian

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Railway . The customer in the case of KTMB is also finding different new product to be considered as an alternative. If substitution is easy and substitution is viable, then this weakens further power of AnsaldoSTS as the incumbent.

And fifthly, Threat of New Entrant, here explaining that power is also affected by the ability of other new railway player trying to enter this market. If it costs little in time or money to enter your market and compete effectively, if there are few economies of scale in place, or if currently railway in Malaysia have little protection for key technologies, then new competitors can quickly enter your market and weaken your position. Today AnsaldoSTS has strong and durable barriers to entry, they can preserve a favorable position and take fair advantage of it. Among other things the client KTMB is demanding better discount from AnsaldoSTS the incumbent supplier for its signaling spare parts equipment.

VI.

Two Main Competitive Force Identified in AnsaldoSTS

I would like to highlight two main competitive forces that the oligopoly player has use to its advantage. Firstly, the main competitive forces here is the rivalry competition forcing AnsaldoSTS to innovate their signalling product offerings with more newer product as a result of more R&D and their strategy of doing more acquisition of strategic technology firm like Selex Communication to enhanced further their position in this very lucrative railway business. Apart from that AnsaldoSTS being the incumbent railway technology has type-approved many of its signal product like its MicrolokII interlocking system and their on-board Automatic Train Protection as a first choice product approved for the use by Malaysian Railway. AnsaldoSTS has also tried to hired local Malaysian contractor to deliver the project resulting in better profit maximization for the organization.

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Secondly, the main forces being the factor of threat of buyers bargaining power. Here, AnsaldoSTS has been very successful in ensuring the buyer KTMB prefer a professional working experience with the AnsaldoSTSs local team . Among other things the client KTMB has worked with the management of AnsaldoSTS and the experienced key project team resulting in a very strong relationship chain which is very hard for other player to penetrate. Besides, when AnsaldoSTS installed and commission its railway system in Malaysia they are putting in all proprietary technology where no other players can source or operate easily. Likewise, the railway players like Siemens Mobility, Invensys and Alstom Transport are doing the similar tactics of specifying and installing their own standard. Here, the buyer is always at the mercy of this railway technology companies, having no choice but to get the spare parts and components from this dominating railway players. As we will see, defending against the competitive forces and shaping them in a companys favor are crucial to strategy

VII.

Game Theory

Game theory is technique often used to analyze interdependent behavior among oligopolistic firms. Game theory illustrates how the choices between two players affect the outcomes and end results of a "game."

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Refer Figure 4 below, to the extreme right illustrates the alternative facing two oligopolistic firms, AnsaldoSTS and Invensys Rail, as they ponder the prospects of , spending on advertising and marketing their signaling products.

Figure 4 : Railway Player Spending on Advertising and Marketing Players

In the top left quadrant, if AnsaldoSTS and Invensys both decide to spend advertising e and marketing, then each receives $20 million in profit.

But, as shown in the top right quadrant, if Invensys spend on advertisement and AnsaldoSTS does not, then Invensys receives $35 million in profit and AnsaldoSTS receives $10 million

However, in the lower right quadrant, if NEITHER AnsaldoSTS or Invensys decide to spend on advertisement, then each receives $25 million in profit. Each c ment, company receive more because they do not incur any advertising expense.

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Alternatively, as shown in the lower left quadrant, if Invensys advertises but AnsaldoSTS does not, then Invensys receives $35 million in profit and AnsaldoSTS receives lower return of $10 in profit. Invensys gets a boost in profit because when advertising it attracts customers away from AnsaldoSTS market share.

Game theory indicates that the best choice for AnsaldoSTS is to advertise, regardless of the choice made by Invensys. And Invensys faces EXACTLY the same choice. Regardless of the decision made by AnsaldoSTS must be wise to advertise. The end result is that both firms decide to advertise. In so doing, they end up with less profit ( only $20 million each), than if they had colluded and jointly decided not to advertise ( the profit return is $25 million each). The final analysis illustrates the two companies cooperating through collusion are better off than if they compete in the market.

VIII. Strategic Plan of Action for AnsaldoSTS for next 5 years

The worlds rail market remained strong during the year with spending underpinned by the need to improve mainline rail and mass transit infrastructure, recognising the importance of rail as an environmentally sustainable and economically efficient means of transport for both passengers and freight. Another point is major cities worldwide trying to reduce the numbers of passenger cars on the road by promoting and improving the passengers ridership on rail by as much as 25-30% of the total transportation. A case here is the Malaysias Klang Valley Light Rail Line Extension for the Kelana Jaya and Ampang Line to extend the lines but almost up to 30km, giving all the present rail players a significant chance to win the billion ringgit contract.

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The annual result of AnsaldoSTS for end 2009 has laid the foundation with consideration of the positive results of the financial year with production volumes higher than, the strong performance posted in 2008. The initiatives to boost cost efficiency in order to increase profitability will continue. In Malaysia and worldwide the railway signalling and transport systems markets are still growing overall, although in certain country like Italy and France which is comes to maturity. AnsaldoSTS is continuing to pursue opportunities in high-growth countries with substantial capacity for infrastructure investment, such as China, India and Russia, with some recent acquisitions.

For the growth beyond 2010, AnsladoSTS will search for opportunities in the transport systems business around the world supported by the systems experience of its group and its subsidiaries their signalling business unit in the various markets. The Companys positive financial situation allows it to closely monitor happenings in the sector in order to search for and select any investment opportunities in support of growth, analysing possible acquisitions or equity investments in companies offering a complementary presence in new markets of interest to AnsaldoSTS or those having a product portfolio that would expand the Groups existing range of solutions in the railway business. So the current move to acquire some strategic companies with rail product and specialization is crucial for AnsaldoSTS to compete with a wider product portfolio. Also the urgent need to ramp up its research and development to come up with newer signaling product like driverless CBTC train system, solid state microprocessor interlocking and advanced train control software to at least match the competitors or be better in term of innovation.

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From a global economic viewpoint of having a more clean and sustainable public transportation will augurs well for AnsaldoSTS to expand its market territory ahead of its competition to the new emerging market like Brazil, Russia, India and China. The success in Indian railway market is a testimony of its technology expertise in signaling interlocking product complement with local supports. A positive growth for the next 5 years for AnsaldoSTS will be possible with the support of a good human capital development and retention policy. Meaning AnsaldoSTS must reward the good performer in the company to ward of the competition in an intense war for talent in this niche rail market. And, lastly the continuous effort to enhance its customer relationship management with better support and better on-time project delivery.

IX.

Conclusions

The lesson from this micro economics paper has taught me that the importance of understanding the dynamics of the micro economics using Porters five forces of competive analysis to develop a strategic game plan for AnsaldoSTS to compete and move up their position and to further sustain the organizations market share and thus their better position in the global railway industry.

By understanding the current global megatrends I can better address this challenges. There are like global climate change, urbanization, globalization, demographic change, a move into green technology. Here, my organization will be able to aligned its strategy to some up with solution in addressing the urban mobility and environmental friendly modern transportation.

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With the understanding of the theory learned and analyzed here I can further work on a strategic business plan to allow the company AnsaldoSTS to remain competitive and successful in winning more contracts in the ever changing and shifting of the business terrain in this new post recession global economy.

X.

REFERENCES 1. Sloman and Hinde, 2007, Economics for Business, Prentice Hall, 2. Porter, March-April 1979, How Competitive Forces Shape Strategy, Harvard Business Review School, page 86-93 3. Useem, 1999, Foundation of Leadership, Wharton, University Pennsylvania 4. Begg D. and Ward D.,2006, Economics for Business, Berkshire, McGraw Hill 5. Layton, A Robison, Tucker, Economics for Today,Thomson Australia 2004 6. Ehnke, Fulton, Akridge, 2004, Industry Analysis- Five Forces, Purdue University 7. Hall & Liebermann, 2004, Economics Principles & Application 8. Sweezy, 1939, Demands Under Condition of Oligopoly, Journal of Political Economy 9. Razeto , Nov 2009, AnsaldoSTS SpA Annual Report 2009, www.ansaldosts.com, London 10. Investor Relations Invensys plc, Dec 2009, Annual Report and Account 2009, www.invensys.com 11. Investor Relations Siemens , Nov 2009, Annual Report 2009, www.siemens.com/annual-report 12. Investor Relations Alstom, Dec 2009, Annual Report 2009, www.alst

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XI. BIBLIOGRAPHY

Bernheim, B. D. and Whinston, M. D. (2008), Microeconomics, McGraw-Hill. Frank, R. H. (2008), Microeconomics and Behaviour, 7th ed., McGraw-Hill. Pindyck, R. S. and Rubinfeld, D. L. (2005), Microeconomics, 6th ed., Pearson/Prentice-Hall international edition. Perloff, J. M. (2007), Microeconomics, 4th ed., Pearson. Perloff, J. M. (2008), Microeconomics: theory and applications with calculus, Pearson. Salvatore, D. (2003), Microeconomics: theory and applications, 4th ed., Oxford University Press. Snyder, C. and Nicholson, W. (2008), Microeconomic Theory: basic priciples and extensions, 10th ed., London : Thompson South-Western. Sice, P., E. Mosekilde, A. Moscardini, K. Lawler and I. French. (2000), Using System Dynamics to Analyse Interactions in Duopoly Competition. Varian, H. (2006). Intermediate Microeconomics: a modern approach, 7th ed., W.W. Norton.

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