An oligopoly is a market state where there is a limited amount of competition available for consumers to consider. When this structure is in place for an economy, then only a small number of producers, distributors, and sellers interact with the customer base to distribute items. There are times when only two different providers for some products exist.
Although this market state can occur at a societal level across all industries, such as what you can find in some communist governments or communities living on the socialism scale, it is usually present within a specific industry. Oligopolies are present throughout the world today, and in some market sectors they are rising rapidly. It typically occurs when one corporation dominates a specific market, but it can also be present when a handful of them have a significant influence over what happens.
One of the most significant oligopolies that exists in the world today involves the national mass media and news outlets in the United States. 90% of the active media outlets in the U.S. are owned by just 6 corporations: Time Warner, Viacom, CBS Corporation, NBC Universal, Walt Disney, and News Corporation. Apple and Android have an oligopoly on smartphone operating systems, while the automobile industry has one through the actions of the GMC, Ford, and Chrysler brands.
There are several advantages and disadvantages of an oligopoly when it forms. Here are the key points to consider.
List of the Advantages of an Oligopoly
1. An oligopoly can adopt a competitive strategy.
Although an oligopoly can adopt a strategy which leads to inefficiencies and a lack of innovation, it can also work toward competitive outcomes if it so chooses. When the companies involved use this advantage to their benefit, then the economic result is similar to what is available under more competitive market structures. Consumers can even benefit from lower prices and better quality goods and services in this situation. The market itself will still lack competition, but the behavior of the organizations can still be highly competitive.
2. The extra profits earned from an oligopoly can go into research and development.
When an economy experiences an oligopoly in some way, then it can create a dynamic set of products and processes through a desire to be innovative. Because the level of profits is often super-normal in this state, the extra funds can funnel toward research and development projects that can help consumers in a variety of ways. We often see this advantage when looking at the outcomes presented by the pharmaceutical industry as the higher cost of medication helps to fuel new research into drugs that could help to reduce the impact of disease.
3. It can bring price stability to the market.
Although the consumer prices in an oligopoly are often higher than what they would be under regular competition levels, a society can experience significant price stability benefits because of the actions of each organization. This advantage allows consumers to start planning ahead for needed expenses so that there is less debt for them to manage. It allows work to stabilize their expenditure habits, eventually working toward a stabilized trade cycle that takes advantage of the conditions of the global economy.
4. Oligopolies can offer more information to their consumers.
The companies involved in an oligopoly are still competing for customers. Because there are fewer choices available in the market, these companies must take their outreach campaigns to new levels to draw attention to their products or services. You will discover that marketing efforts typically center around the amount of value and innovation that one company says it can provide over all of the others.
Apple chooses to market itself more as a superior brand than a product which is substantially better than its competitors. One could even argue that the technology components in their devices are inferior in some ways. Their ecosystem with the App Store, the launch of Siri, and the development of products like the Apple Watch causes more investments into the brand. This process creates loyalty to the company that becomes challenging to break over time.
5. It allows for more product refinement to occur.
Remember when the first Apple iPhone came out more than a decade ago? People bought into the concept because there was familiarity with the design if you were already using an advanced iPod to manage your music. When there is enough money be transferred into the research and development process, it doesn’t just go to the creation of new, possibly revolutionary products. This investment can help to refine the current inventory as well to increase the overall value proposition that consumers experience in each situation.
List of the Disadvantages of an Oligopoly
1. Higher concentration levels reduce consumer choice.
When there are only a handful of organizations that are active in a specific industry, then the higher concentration levels in society can reduce the amount of choice that consumers receive. Imagine that you’re in the market right now to purchase a commercial aircraft to start building a new fleet. There are only two global airliner manufacturers left: Boeing and Airbus.
“Now that Bombardier is out of the segment, the CSeries clearly has only a niche future as part of the Airbus line,” writes Michael Boyd for Forbes. “That puts finis to the last potential and truly threatening competitor to Airbus and Boeing.”
2. Collusion is possible in this structure to further reduce competition.
There are three specific types of collusion that are possible with an oligopoly: overt, covert, and tacit. The first occurs when there is no attempt made to hide an agreement. One could argue that OPEC is a form of this option. Covert ones occur when the companies involved attempt to hide the results of their “partnership,” often done to avoid the detection of regulators for some reason. Price fixing is a common example of this second form.
The third option is tacit collusion and it arises when organizations work together even though a formal or informal agreement is not in place. This issue can be difficult (or impossible) to prove, but it can result in an increase in regulation over an industry if negative market behaviors are suspected.
3. It can lead to decision-making bias and irrational behavior.
Because an oligopoly removes the threat of competition from the market, those who practice it are sometimes free to manipulate the consumer decision-making process. There are several ways to do this, with the complexity of a mortgage being one of the best examples of this disadvantage. If customers don’t fully understand how a process works, then they fall back on generalities and the “rule of thumb” choices that other people talk about online or in reviews.
This disadvantage can even inspire consumers to make purchases which add no utility their lives. There are even times when the companies involved in the oligopoly will encourage harmful financial decisions to their customers because their actions will improve revenues and profit margins.
4. Deliberate barriers to entry can occur with an oligopoly.
When there are firms participating in an oligopoly, then their goal is to keep disruptors out of their industry at any cost. They can do so by creating a complex series of barriers that prevent others from offering new products or services. There are several ways that this disadvantage can keep innovation from coming to the market.
- Government regulations backed by oligopoly-based special interests that can create restrict licensing, limitations to raw materials, and costly regulatory hurdles.
- Higher start-up costs may occur if patents or proprietary methods are the primary way to begin operations within a specific industry.
- Operating on an economy of scale like Walmart allows for lower prices and greater accessibility to customers.
- Working together to limit new companies from having access to distribution channels or suppliers can cause this issue too.
5. There can be a potential loss of economic welfare in an oligopoly.
Because consumers are given limited choices with an oligopoly, there can be more saving activities in the economy than spending. Any interactions that occur at the retail level become minimal unless there is a core need for the products or services offered through this economic structure. This disadvantage is one of the reasons why the United States pushes toward energy independence by creating new domestic oil and gas resources. By limiting the purchases through OPEC for these necessary fossil fuels, less wealth transfers to the companies and countries who took advantage of this structure in the past.
6. An oligopoly does not require efficiencies to be useful.
Many industries that function through an oligopoly tend to inefficient with their production and allocation. There is no need for them to try to make their products or services cheaper because they consumers must purchase them if they have a need. It allows them to fix prices artificially high in a manner similar to a monopoly, but with the presence of other companies in the marketplace.
7. The economic benefits require perfect compliance to be beneficial to society.
When there is an oligopoly in place for a specific industry, then the government typically tries to subsidize the firms in that segment to encourage continued growth and prosperity at a national level. The economic benefits that come from perfect compliance can create more jobs, higher wages, and better living conditions for consumers. The only problem with this structure is that the companies often pocket the tax breaks and subsidies instead of passing them along to the consumer.
Nike is one of the biggest benefactors of government subsidies, receiving over $2 billion in appropriations that cover 75 individual programs. Intel receives almost $4 billion per year covering 59 different subsidies with its chips. Then there is Boeing, who receives over $13 billion from 148 unique financial handouts. In 2013, the company receive the highest tax-break in the history of the United States under the threat of moving the company to a different location.
8. Customers must put up with poor service because there are no other choices.
In March 2019, CNN and other news outlets reported that Boeing was delivering airplanes to the U.S. military without having the final product go through an extensive inspection. There were tools left in the planes after handing them over, the aircraft were full of trash, and even nuts and bolts were scattered around the KC-46s that were ordered.
When there is an oligopoly present, then the companies know that customers have no choice but to work with them to have their needs met. There is no desire to provide excellent customer service or a quality product because no competitors exist to challenge them. That leaves a customer in a position where they must accept the abuse to get the bare minimum of what they require or to go without.
9. Companies can add fees and charges because there is no competition.
For more than 15 years, the telecommunications industry was putting on overage charges, termination fees, and other unfriendly practices that were helping the companies bring in millions of dollars in extra revenues each year without really providing a service. If you had a cell phone, then you had things good enough. Even when T-Mobile decided to break from that tradition, their desire to merge with Sprint (and others) over that time has only encouraged the oligopoly to continue.
When companies act in parallel with one another, making the same choices that impact the marketplace, then this creates the same effect as a monopoly. It is curious to see how the government won’t put up with a single company that acts in ways that are harmful to the consumer, but it sees 3-4 of them taking the same actions as “competition.”
10. It creates the appearance of choice without really giving you one.
Consumers are often misled by product labeling. When they see a different brand name, then it seems like they are choosing a competitive product. That thought couldn’t be further from the truth. When you visit Walmart, Target, or your local drugstore the next time, take a moment to review what is available in the toothpaste aisle. You will see dozens of different brands and variations available on the shelf.
Only two firms control 80% of the toothpaste market in the United States: Procter and Gamble and Colgate-Palmolive. Even Tom’s of Maine fits into that oligopoly since it isn’t a true independent brand. You’ll see this problem in the beverage industry, the dairy industry, and many other consumer segments that see multiple brands often feel like a competitive market, but they really are not. Even the beer industry fits into this category. 1
Conclusion of the Pros and Cons of an Oligopoly
An oligopoly should not be confused with a monopoly. There must always be at least two firms active in a specific segment of the market for this structure to be present. A monopoly means that there is only one company supplying all of the customers for that specific industry. The New Yorker once said that it wasn’t monopolies that were the problem in the United States – it was the oligopolies.
Although an oligopoly offers theoretical benefits if the companies involved are all good actors, the reality is quite the opposite. When only a handful of companies hold most of the market, then the lack of competition often creates a lack of innovation.
The pros and cons of an oligopoly depend on your perspective of the market. Businesses in this situation can manipulate pricing structures to innovate, but they can also take those actions as a way to boost their profit margins without regard to the consumer. The advantages help to promote innovation and choice, while the disadvantages can force a lack of spending in the local economy. That is why the presence of this economy in specific industries is watched carefully since it can do as much harm as it can provide for the common good.
Natalie Regoli is our editor-in-chief. The goal of ConnectUs is to publish compelling content that addresses some of the biggest issues the world faces. If you would like to reach out to contact Natalie, then go here to send her a message.