Representatives of the Harvard approach claim that there exists a causal chain from the structure of a market through the conduct of the participants in the market to the performance of the market. With regard to market structure, two factors are taken to be of overwhelming importance: (1) the number of suppliers, and (2) the concentration of their market shares. Other factors that have at times been recognised abound: the degree of product differentiation, the degree of market transparency, the kind of production technology used (are economies of scale relevant?), the relevance of barriers to entry, the market phase (introduction, expansion, saturation, decline), the degree of vertical integration, elasticities of price or income, etc. Notwithstanding the large number of factors that could influence market structure, the two factors playing the key-role always remained the number of suppliers and their market shares.
Market conduct is operationalised by the way market participants make use of possible strategies. Here the price-setting behaviour turned out to be of central importance. Other factors sometimes subsumed under the conduct of firms include the propensity to act competitively but also the propensity to enter into anti-competitive agreements with competitors. Market performance is measured by looking at prices, qualities, quantities, but also technological progress, and, quite importantly, profit rates.
Drawing on the theoretical model of perfect competition, the “optimal” sequence of structure-conduct-performance would translate into polypolistic markets (structure) in which firms have small market shares which leads to their charging prices that are equivalent to marginal cost (conduct), which results in a profit rate that just covers the costs of factor inputs (performance). But the representatives of the Harvard approach were unsatisfied with the concept of perfect competition. This was exactly the reason why Clark (1940) proclaimed the alternative of “workable” competition. According to representatives of workable competition, perfect competition models are fine in order to bring about static efficiency, i.e., the situation in which welfare cannot be improved by reallocation of any factors. Static efficiency is threatened by market structures with a low number of competing firms that have, in turn, high market shares. But the concept of perfect competition is a static concept. There is no space for innovation and technological progress, in short: for dynamic efficiency. Innovation presupposes the capacity to invest into research and development. According to the representatives of workable competition, a certain degree of concentration of firms is needed in order for them to be able to finance research and development.
Concerning “optimal” market structures, representatives of the Harvard approach thus find themselves in a dilemma between static and dynamic efficiency. They usually opt for a “middle of the road” approach: allow a market structure with a moderate degree of concentration but ensure by way of an active merger policy that it will remain moderate because high levels of concentration would enable firms to reap monopoly profits by setting the price above marginal costs thus violating static efficiency. To ensure moderate levels of concentration, mergers were often prohibited. If there is indeed a clear and unequivocal causal link between structure, conduct, and performance, then, in order to ascertain the workability of a market it is, at least in principle, sufficient to test for market structure or market conduct or market performance. This means that should market performance be unsatisfactory, this would be sufficient for proclaiming market structure to be unsatisfactory – and possibly demand political intervention in order to make it “workable.”
For a long time, the primary occupation of representatives of this approach consisted in assembling industry data and estimate regressions of the type
in which Пi stands for the profitability of an industry i which is supposed to be determined by the structure S of that industry. For a long time, empirical evidence was supposed to be in favour of this simple three-step process. Shepherd (1972), e.g., presented evidence showing that between 1960 and 1969, a significant positive correlation between the market share of a firm and its profitability existed. Many of the representatives of this approach took evidence of this as sufficient for a competition policy of not allowing mergers to be carried out but at times also of busting existing companies (such as the famous AT&T case). The Harvard approach thus seemed to be the perfect justification for interventionist competition policies.
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