Introduction
Oligopolies, markets dominated by a few large companies, are not created randomly. They emerge from certain conditions and actions that facilitate their formation. As is evident, many high costs or regulations serve the purpose of enabling oligopolies to be formed; however, there are a few subtle mechanisms that allow the formation of oligopolies as well. This post will discuss how these enablers move beyond simple explanations and study the forces constructing these market structures.
Table of Contents
Key Mechanisms That Enable Oligopoly Formation:
1. Predatory Pricing and Limit Pricing:
Strategic pricing policies are aimed at driving out competition, deterring new entrants into the market, and allowing the development of an oligopoly.
2. Predatory Pricing:
Established companies engage in predatory pricing by taking a loss in the short term by selling their products at prices so low that the cost of production is above the revenue earned from the sale. This strategy actively removes competitors and increases the firm’s market share. The short-term loss helps maximize profits over the long run.
3. Limit Pricing:
In order to deter potential new firms from entering the market while making a profit, established companies set their prices just above the cost of supplying the product. This strategy increases prices, reduces competition, and ultimately enables only a few companies to thrive in the industry.
4. Control of Essential Resources or Inputs:
When a couple of firms have dominion over resources crucial for production in a market, it becomes easy for them to bar competitors from entering the market. For instance, a firm with a monopoly over the supply of rare earth elements can either single-handedly produce goods that pertain to it or restrict access to other companies and block new entrants to the market.
5. First-Mover Advantage Coupled with Scalability:
While being first in a market is important, it appears to be most important in a market with the potential to grow. It’s not nearly as impactful being the first company to sell software in a new segment as it is to be the first social media company. The first mover can gain a presence and grow at an astonishing rate. Branding, a large user base, and significant economies of scale allow the firms that grow quickly to dominate the market, forcing out competitors and making it extremely difficult for new firms to enter.
6. Strategic Use of Intellectual Property:
Active competition can be suppressed by utilizing patents, copyrights, and other forms of intellectual property. For business purposes, a company’s fragmented patent portfolio may contain patents for technologies that they do not use. Sometimes, they will purchase patent rights from rivals to obliterate any chance of innovation becoming competition. By doing this, they have complete control over the specific innovation and can prevent others from utilizing it in the market, which stifles competition, enabling oligopolies to reign.
7. Standard Setting and Gatekeeping:
A market can only be penetrated by new participants when a few companies set the gates by establishing industry standards and performing the gatekeeping function. Due to this, firms that set industry standards can perpetuate their market dominance by fostering a system that is only beneficial to them, thus eliminating competition. An altered system designed by the companies it affects stunts competition, allowing only industry incumbents to thrive.
8. Collusion and Tacit Agreements:
While explicit collusion is prohibited, major players engaging in tacit collusion could easily engage in an oligopolistic market structure. Companies can set excessive profits by boosting prices and limiting output with this kind of agreement. An oligopolistic structure is most likely to exist when firms do not compete with each other.
The Dynamic Nature of Oligopoly Formation
Let us note that the enablers do not work independently. They are neither isolated occurrences nor happen simultaneously but form part of a process where influential firms exercise control over the market to create a balance of power. This process can begin in contests. The evolvement of the structure can slowly take place into an oligopoly with the built-up of the firms.
The Broader Implications
Ascertaining the less evident factors is critical since they show that oligopolies emerge not simply due to technological barriers or regulation but also from sophisticated strategic activities and market interactions. These elements are complex for new entrants to counter, and innovation needed to solve this imbalance.
Conclusion
It is crucial to grasp how oligopolies formed. Practices such as resource monopolization, strategic IP allocation, setting industry standards, and collusion are as vital as predatory pricing and first-mover advantages. All these practices are active barriers to market entry by new and existing competitors. These dynamic mechanisms make it easy for firms and regulators to deal with the problems posed by oligopolistic markets.
Which of these enablers do you see playing a significant role in forming oligopolies? Share your thoughts and insights in the comments!