An oligopoly is a market structure that involves a small group of large companies that have all or almost all sales in the industry and often collude to reduce competition. The level of competition among firms within this market system is lower, companies have monopoly power and obtain higher revenue.
Why do oligopolies exist?
Companies often collaborate to set a specific price or output rather than compete with each other because of the several economic benefits oligopolies allow to obtain. Firms in oligopolies control the prices which makes it more difficult for other businesses to enter the market. In this way, they prevent the emergence of new competitors that can hinder their businesses. New companies can charge lower prices and jeopardize the longevity of the colluding companies’ revenues.
You can find oligopolies among steel manufacturers, oil companies, railroads, airlines, and pharmaceuticals. In this market structure, companies choose to obtain the benefits of collaboration rather than compete with each other. They set prices together or choose a leader that will increase the prices and other firms will follow.
Now that you know why oligopoly exists, let’s pay attention to the top features this market structure has.
Top 5 Features of Oligopoly
- Interdependence in decision making
- Price rigidity
- Conflicting attitude
- Monopoly power
There are four main types of market structures: pure competition, monopoly, oligopoly, and monopolistic competition. To distinguish oligopoly from other structures, we’ll now review the main features of this market system.
- Interdependence in decision making. A small number of big companies in an oligopoly can’t operate independently. For example, the decision of one firm to launch a big advertising campaign will provoke countermoves. Since firms in an oligopoly offer homogenous products, they all influence price and output, so they can’t ignore the actions of their rivals.
- Price rigidity. Each company has to stick to the price in this market system. If one company cuts down the price, competitors will make a more drastic reduction that might lead to a price war. It will let no one benefit.
- Conflicting attitude. In this market structure, you can find two attitudes. In the first one, companies understand that competition can’t bring them benefits and try to cooperate to maximize their revenue. In the second one, the idea of increasing profit leads to conflict and antagonism.
- Monopoly power. A limited number of companies in an oligopoly that have a big market share enables these firms to control the price and output. Therefore, this market structure has some monopoly power.
- Advertising. It is a powerful instrument with the help of which a company in an oligopoly can start an aggressive campaign to capture a big part of the market. In this scenario, other firms will have to use defensive advertising.
Now it’s time to move to the pros and cons.
Advantages and Disadvantages of Oligopoly
Companies in oligopolies are large and they set standards to control prices and competition. You might have asked yourself why oligopolies are so popular especially in mass media, the tech industry, airlines, entertainment, and social media platforms. The answer is simple — because of the advantages, this market structure brings to businesses. So it’s time for you to find out the pros of oligopolies:
- low level of competition;
- higher potential to receive big profits;
- products and services controlled through oligopolies are in great demand;
- a limited number of companies makes it easier for customers to compare products;
- easier for people to choose products;
- competitive prices;
- a better quality of products and services since brands need to survive in the market;
- better customer support;
- price stability within the market;
- more informative ads.
However, everything has drawbacks, oligopolies have them too. The major cons are:
- limited customer choice;
- high barriers to entry;
- companies uninterested in innovations since the level of competition is low.
Now that you know the advantages and disadvantages, let’s proceed to the next section to find out how an oligopoly works.
How does an oligopoly work?
In oligopolies, collusions are sequential. They are necessary to define a price or output and boost the profit. That’s why this market structure is somehow similar to monopoly. Such a market consists of only a few big companies so they collude to obtain the necessary results.
By increasing the price, they have the opportunity to receive higher profits and produce a smaller amount of goods. Yet, collusive oligopoly is risky since the most efficient companies will break ranks by reducing their prices. These firms break the agreement mainly to increase their market share.
A threat of defection, a low level of coordination, and price-fixing illegal in the US are the factors that deter collusion. That’s why these companies often face the possibility that one of them can agree to collude and then break the agreement and undercut the revenue.
Now that you know how oligopolies work, we’ll proceed to the difference between oligopoly and monopoly.
Oligopoly vs Monopoly
Let’s review the features of these two market systems to make the difference clear.
In an oligopoly, there are two or more companies that control the market. In this market structure, no firm can keep the others from influencing the industry and offering goods that differ a little bit. Since it doesn’t have any superior force, firms prefer to collude rather than compete. This fact makes it extremely difficult for other players to enter the market.
In a monopoly, there’s one dominant firm that sells goods or provides services. A company in this market structure has enough authority and power to prevent competitors from entering the marketplace. There might be various reasons that make it difficult to enter the industry: technology, patents, government regulation, or capital requirements.
In a monopoly, we can find only one seller, a price maker that can set high prices and reduce the choice for customers. Nevertheless, buyers will pay the price if there are no substitutes available.
Let’s move to the next section where we’ll walk you through the types of oligopoly.
Types of Oligopoly
Further, we’ll review four main types of oligopolies based on the relationships between companies within the market:
- perfect is when companies offer homogenous products (for example, steel and aluminum industry);
- imperfect is when firms manufacture differentiated products (for instance, soft drinks and cigarettes);
- collusive is when companies cooperate in setting the price and output;
- non-collusive is when firms within an oligopoly market compete with each other.
Next, we’ll discuss the pricing strategies of oligopolies. So let’s dive in.
Pricing Strategies of Oligopolies
Companies in oligopolies can use predatory pricing which means keeping prices very low that can sometimes even be under the full cost of production. This strategy is used to force competitors out of the market. Besides, firms also implement a limit-pricing strategy to hinder new companies from entering the market. In this scenario, firms reduce the price sufficiently and make it unprofitable for other players to enter.
You can also encounter cost-plus pricing in this market structure. It’s a strategy in which the price of a good is defined by adding a specific mark-up to a product's unit cost. It is useful for firms that manufacture different products and for oligopolies since the few companies that dominate in the market often share the same expenses. One of the examples is petrol retailers. Nevertheless, there is always a risk because competitors can adopt a more flexible method to obtain a bigger market share.
To compete in the oligopoly market, you should know the main peculiarities of this market system which we’ll discuss next.
How to compete in the oligopoly market?
The interdependence that exists within an oligopoly determines the way companies compete. The decisions on price and output of the firms within this market system depend on the behavior of other companies. Businesses that operate under the rules of oligopoly can’t act independently. They usually take into account the actions of their closest rivals when making decisions.
Let’s take Texaco that operates in petrol retailing, for example. Say, the company wants to get a bigger market share by cutting down the price. If the company’s competitors Shell and BP find out about this fact, they can reduce prices as well.
The way firms compete in an oligopoly depends on the company’s objectives, the nature of goods or services, and the contestability of the market. Some firms compete on price, others on the quality of their products.
When trying to demonstrate their benefits to the leads and customers, oligopolists prefer to implement non-price competition. It involves distinguishing products or services to increase sales by using methods other than price.
Now that you know how companies compete, it’s time to find out how to enter this market.
How to enter an oligopoly market?
Oligopolists always maintain their dominance in a market which makes it hard for new players to enter. Oligopolies have high barriers to entry. This means that many obstacles hinder new players from joining the industry. When giving a thought to entering this market structure, there will be barriers such as economies of scale and patents, government regulations, and expensive technology. Companies need to overcome these and other challenges if they want to be a part of an oligopoly.
To grab some inspiration, let’s dive into examples.
Examples of Oligopoly
Nowadays you can find different oligopolies in various industries. If you are curious about corporations that belong to this market structure, we’ll walk you through some of them.
- Entertainment. Hollywood with its movie production studios has been an oligopoly for a long time. Disney, Warner Bros. Pictures, Universal, and Sony are the biggest movie studios based on their market share.
- Airlines. The airline industry of the United States can be also referred to as an oligopoly since four main domestic airlines dominate in the market. They are American Airlines, Delta Air Lines, Southwest Airlines, and United Airlines.
- Search engines. People use search engines every day for their personal needs. There are around ten most popular search engines in the world. However, only a few of them dominate the market. The two major search engines are Google and Bing. Google is a leader among search engines and undoubtedly the most popular search engine. In February 2021, Google had 86.6% of the search market share. To compare, Bing had 6.7%.
- Social media. As of 2021, there are 3.96 billion users of social media worldwide. Today, we can’t even imagine our lives without the main social media platforms like Facebook, Instagram, and Twitter. The market is dominated by the mentioned channels. Facebook is considered the world’s biggest social media platform because it has 2.45 billion monthly active users.
- Big technology. When we talk about oligopolies in big tech, we usually mean operating systems for phones, laptops, or PCs. Among smartphones, customers can choose between Apple iOS and Android. If you need a computer or laptop, the choice isn’t too big either since Apple and Microsoft Windows are the most popular and thus the most influential.
- Automobile manufacturers. Although the world knows dozens of automobile manufacturers and people can choose any, in the US the situation is quite different. General Motors, Ford Motor Company, and Stellantis North America are the largest automakers. They represent an oligopoly.
You can see the examples of oligopolies in your everyday life: platforms you use for communication, operating systems of the smartphones or laptops you buy, search engines you know. Now you can easily distinguish this market structure from others.
- The article “What is an Oligopoly?” defines the term and explains how oligopolies work.
- The article “What Are Current Examples of Oligopolies?” provides readers with current examples.
- The article “Reasons for the Existence of Oligopoly (7 Reasons)” explains why oligopolies exist.
Last Updated: 20.04.2021