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Oligopoly

Oligopoly: A market dominated by a few large firms.

Oligopoly is a very common market structure, e.g. a handful of firms supply most of the world’s cars, and a few big banks dominate banking in many countries. Smaller firms can often survive alongside the giants by serving a niche, a small group of customers that the dominant firms do not cater for.

Main features of oligopoly

• Few firms: the market is led by just a few firms, perhaps three to six.
• Large firms dominate: the leading firms have a large share of the market between them. They usually set the price, and smaller firms often copy it.
• Different products: the firms’ products are close substitutes, but each firm tries to make its products different, e.g. in style, size or quality.
• Barriers to entry: high set-up costs and heavy spending on brands keep new firms out, which protects the leading firms’ high profits.
• Collusion: the leading firms may agree not to compete, e.g. by fixing a high price, sharing out the market by region or restricting output. Collusion is illegal in many countries.
• Non-price competition: firms compete through advertising, branding, loyalty cards, special offers and product differentiation, instead of on price.
• Price competition: prices often stay the same for long periods, with the market leader setting the price. If one firm does cut its price, the others usually have to follow, which can start a price war.

Collusion: informal agreements between firms to restrict competition.

Price war: where one firm in the industry reduces price causing others to do the same.

The firms are interdependent: whatever one firm does, e.g. cutting its price or launching a big advertising campaign, affects the others, so they must react or risk losing market share.

Advantages and disadvantages of oligopoly

Cartel: where a group of firms or countries join together and agree on pricing or output levels in the market.

Advantages of oligopoly:

• Choice: the firms compete by launching new brands, and small firms serving niches add even more choice.
• Quality: one way to make a product stand out from rivals is to make it better, so quality may be high.
• Innovation: large firms have the resources to spend on research and development, and a firm that develops a better product can win customers from its rivals.
• Price wars between oligopolies: when one firm cuts its price sharply and the others follow, consumers pay less. Stable prices at other times also give consumers some certainty.

Disadvantages of oligopoly:

• Collusion and cartels fixing high prices: if firms agree to fix prices or restrict supply, consumers pay more. A successful cartel can act like a monopoly, e.g. OPEC, a group of oil-producing countries, agrees to limit oil output to push up the price.
• Choice: in some markets there is little real difference between the products, e.g. petrol. If firms share out a market by region, each area has only one supplier.
• Quality: the better quality may exist only in consumers’ minds, created by advertising.
• Innovation: the huge sums spent on advertising and promotion might be better spent on developing new products.
• Price wars between oligopolies: price wars do not usually last long, and one firm may be forced out of the market. With fewer rivals left, the survivors may push prices even higher.