Market Structure Affect on Dow Chemical

Dalton Wu

Industrial Organization

Dow Chemical Research Paper

        The market structure of an industry plays an important role in how firms act and perform.  Changing market structure forces firms to adapt and change their business practices to best succeed.  Dow Chemical is a part of the chemical manufacturing industry and has been a member of the Fortune 500 list for over the past 50 years.  However, Dow Chemical was not always the dominant firm throughout the years.  Altering market structure and demand of the chemical manufacturing industry has forced Dow Chemical to alter business tactics and compete for market share.

        In 1897, Dow Chemical was founded by chemist Herbert Henry Dow.  The original business plan was based off a new method of extracting bromine that was trapped underground within brine, a highly concentrated salt solution.  Dow only offered two products at the inception of the company, bleach and potassium bromide. Dow’s products quickly gained success.  Due to the rapid success, German bromide producers flooded the US market selling bromide well below market price in an effort to drive Dow Chemical out of the European market.  Herbert Dow opted to not compete with the German producers directly; he instead bought the low-priced bromide and flipped it on the European Market for a healthy profit (Taylor, 2013).  This under cut Dow’s competitors and led to Dow chemical becoming a global threat in the chemical manufactory sector.

        The market structure of the chemical industry is unique in that the goods are substitutable and relatively elastic.  The market structure is also very dependent upon entry barriers, the use of patents, anti-trust policy, shifts in demand and the use of joint ventures.

        Substitutable goods and elastic prices usually pertains to a highly competitive industry.  However, entry barriers create a more concentrated chemical manufacturing market.  Obvious entry barriers are the cost of manufacturing plants.  Chemical manufacturers have immense sunk costs with building out plants.  Dow Chemical built out its first plant in 1941, located in Freeport, Texas.  The plant led to Dow Chemical taking advantage of economies of scale as marginal costs in producing chemicals is very small.  With the addition of the Freeport plant, Dow chemical was able to diversify its product line and decrease production costs (University of Michigan, 2006). The success of the first plant led Dow to continue expanding product lines and building out more plants.

        Even during the early days of Dow Chemical, the firm created the tradition of rapidly diversifying its product line and expanding into other sub categories of the chemical industry. Within the first twenty years of the company’s inception, Dow was already a major producer of elemental chlorine, agricultural chemicals, magnesium metal, phenol and other dyestuffs.  This diversification has helped Dow Chemical grow into an industry leader and global firm.  

        Diversifying is essential to maintain dominance in the chemical industry because many of the products are substitutable goods. Goods that are highly substitutable leads to an increase in competition.  Substitutable goods also tend to be more price elastic due to the fact that price is the only differentiating factor.  The nature of the good leads to the market being competitive.  Diversification into sub categories allows firms to compete in a more concentrated market.  Dow Chemical will only have to compete directly against other firms that produce products in the same niche sub categories.  An increased market concentration and expanded product line lead to greater sales and revenues.

        Many chemical manufacturers have multiple subdivisions in which they operate in, making competition in those subdivisions more concentrated than the general chemical manufacturing market.  Dow chemical began expanding outside North America and diversifying with its launch on a consumer products division in 1953.  The main product at the time was saran wrap.  Dow’s booming chemical and plastics manufacturing segments ultimately led to Dow Chemical expanding. The expansion of Dow Chemical’s business segments allowed the firm to have more market share and power in those segments.  Acting as a monopoly in those sub categories, Dow was able to capture more market share and revenues.  Dow experienced a boost in its Fortune 500 ranking when it heavily diversified its product line in the mid 70’s until it finally slowed 20 years later.

        Market structure is also determined by demand of the goods.  When thinking about chemical production, demand is dynamic.  External factors such as wars, natural disasters, and seasonality affect demand.  These factors can temporarily shift demand, causing entry and exit in the market.  During war times, demand for chemicals and Dow’s products increase.  Whereas something like seasonality causes a shift decreasing demand.

        The Vietnam War is a great example of how external factors can increase demand for Dow’s products.  The United States military used napalm bombs dropped from planes as a means of war.  Dow Chemical was one of several manufacturers who was awarded a government contract to begin producing napalm B compound.  Due to antiwar campaigns and negative backlash from the public, all the other firms involved in the contract backed out except Dow. The contract was started in 1965 and lasted until 1969.  Dow was also involved in a similar situation with Agent Orange.  Agent Orange is a chemical defoliant containing dioxin.  Dow was among one other company who got the military contract (Herman, 2012).  

        Seasonality of some of Dow’s products also affect demand.  Dow chemical is a large producer of agricultural related chemicals such as insecticides, herbicides, and fungicides.  These products are only used at certain times throughout the year.  Once the harvest season arrives, there is no longer any use for some of the agricultural chemicals.  Firms tend to exit the agricultural chemicals market during this time and focus on more in demand products.  A dynamic, shifting demand curve makes cash flow in the chemical industry more sporadic than others.  This is another entry barrier, as a new entrant firm will have to have enough capital and efficiency to continue operating without consistent cash flow.  In order to combat the volatility of the demand curve, firms often enter into contractual agreements.

        Contracts are a form of entry barriers.  The contract acts as a competition limiter.  Dow has constructed a large network of buyers who they regularly do business with.  Dow structures their contracts that they are the sole provider of chemicals to specific entities.  Dow is also different than many of the other leading chemical manufacturers because of who the buyers of their products are.  John Tysse, Dow’s vice president of sales and marketing describes Dow as the “chemical companies’ chemical company” because they provide to other industries and firms rather than the end users.  Buyers of their products often enter into contract agreements to negate changing prices and shifts in demand.  This also alters the market in which Dow operates in.  Dow is not in direct competition with many of the other top chemical firms because much of the competition sell to the end users.  Market concentration in the business to business chemical industry is much more concentrated than the more general chemical industry.  Contracts are also a deterrent of entry in the market since a new entrant would need to develop a network of buyers not already under contract.