A2 Micro: Oligopoly

An oligopoly is a market dominated by a few producers. An oligopoly is an industry where there is a high level of market concentration. Examples of markets that can be described as oligopolies include the markets for petrol in the UK, soft drinks producers and the major high street banks. Another example is the global market for sports footwear – 60% of which is held by Nike and Adidas. However, oligopoly is best defined by the conduct (or behaviour) of firms within a market.

The concentration ratio measures the extent to which a market or industry is dominated by a few leading firms. A rule of thumb is that an oligopoly exists when the top five firms in the market account for more than 60% of total market sales.

Characteristics of an oligopoly

There is no single theory of price and output under conditions of oligopoly. If a price war breaks out, oligopolists may choose produce and price much as a highly competitive industry would; whereas at other times they act like a pure monopoly.

An oligopoly usually exhibits the following features:

1. Product branding: Each firm in the market is selling a branded product.

2. Entry barriers: Entry barriers maintain supernormal profits for the dominant firms. It is possible for many smaller firms to operate on the periphery of an oligopolistic market, but none of them is large enough to have any significant effect on prices and output

3. Inter-dependent decision-making: Inter-dependence means that firms must take into account the likely reactions of their rivals to any change in price, output or forms of non-price competition.

4. Non-price competition: Non-price competition is a consistent feature of the competitive strategies of oligopolistic firms.

Duopoly

Duopoly is a form of oligopoly. In its purest form two firms control all of the market, but in reality the term duopoly is used to describe any market where two firms dominate with a significant market share. There are many examples of duopoly; including Coca-Cola and Pepsi (soft drinks), Unilever and Proctor & Gamble (detergents), Bloomberg and Reuters (Financial information services), Sotheby’s and Christie’s (auctioneers of antiques/paintings), Standard and Poor’s and Moody’s (credit rating agencies), BSkyB and ESPN (live Premiership football), and Airbus and Boeing (aircraft manufacturers).
In these markets entry barriers are high although there are usually smaller players in the market surviving successfully.

The high entry barriers in duopolies are usually based on one or more of the following: brand loyalty, product differentiation and huge research economies of scale.

The importance of non-price competition under oligopoly

Non-price competition assumes increased importance in oligopolistic markets. This involves advertising and marketing strategies to increase demand and develop brand loyalty among consumers. Businesses will use other policies to increase market share:

o Better quality of service including guaranteed delivery times for consumers and low-cost servicing agreements.

o Longer opening hours for retailers, 24 hour online customer support.

o Discounts on product upgrades when they become available in the market.

o Contractual relationships with suppliers - for example the system of tied houses for pubs and contractual agreements with franchises (offering exclusive distribution agreements). For example, Apple has signed exclusive distribution agreements with T-Mobile of Germany, Orange in France and O2 in the UK for the iPhone. The agreements give Apple 10 percent of sales from phone calls and data transfers made over the devices.

Advertising spending runs in millions of pounds for many firms. Some simply apply a profit maximising rule to their marketing strategies. A promotional campaign is profitable if the marginal revenue from any extra sales exceeds the cost of the advertising campaign and marginal costs of producing an increase in output. However, it is not always easy to measure accurately the incremental sales arising from a specific advertising campaign. Other businesses see advertising simply as a way of increasing sales revenue. If persuasive advertising leads to an outward shift in demand, consumers are willing to pay more for each unit consumed. This increases the potential consumer surplus that a business might extract.

High spending on marketing is important for new business start-ups and for firms trying to break into an existing market where there is consumer or brand loyalty to the existing products