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OLIGOPOLY

Sociologyindex, Sociology Books 2012

Oligopoly is the situation where a small number of companies own or control the production of a particular good or provision of services within a market economy.

Oligopoly typically arises from the concentration of ownership and provides a challenge to liberal theory which claims benefit from a plurality of producers operating in a very competitive market.

A formal definition of oligopoly is: “...a market structure with a small number of sellers - small enough to require each seller to take into account its rivals’current actions and likely future responses to its actions.” - Recognised interdependence is the hallmark of oligopoly.

Kantzenbach and Kruse (1987, 10) offer a more technical definition asserting that an oligopoly exists, "... if the variation of a behavioural parameter by one of a group of competing firms leads to a perceptible change in selling conditions for the other competing firms…, thus causing them...to respond by changing their own market behaviour."

If a dominant oligopoly already exists, the merger between two of its members or between an oligopolist and an outsider will lead to the oligopoly becoming even tighter. The tighter the oligopoly is, the more transparent competitive conduct will become and the easier it will be for conscious parallelism to occur.

Oligopolies are markets where profit maximising competitors set their strategies by paying close attention to how their rivals are likely to react. In these conditions, firms might differentiate their products, which can benefit some consumers, but at a price. Oligopoly inter-dependence can also foster anti-competitive co-ordination.

Competition laws prohibit collusion that raises prices, restricts output or divides markets. But the laws do not prohibit conscious parallelism. Thus firms in an oligopoly might imitate their rivals’ pricing and other competitive behaviour in a process that harms consumer welfare, yet without reaching an explicit agreement. - The OECD Competition Committee debated oligopolies in 1999. - Extracts.

The greater the likelihood of conscious parallelism appears on the basis of these criteria, the more evidence is needed to refute the presumption of a dominant oligopoly. If as a result of an examination of the conditions of competition it appears that there is no indication of a dominant oligopoly, the competitive process need not be examined further. If such indications do exist, however, it must be examined whether, and to what extent, the members of the oligopoly actually make use of possible parameters of competition.

The more homogeneous the products are in a specific market (e.g. cement), the less likely it is that quality competition is present. There is often no price competition under these conditions due to the high degree of oligopolistic interdependence among the suppliers. That is why residual competition in the form of competition in services, terms, R&D and the provision of advice to customers is particularly important. On the other hand, competition in terms of price and quality currently often exists in the case of heterogeneous products.

The trend to oligopolistic behaviour is less in this case. If the conditions of the oligopolistic presumption are satisfied, the existence of substantial competition before the merger is not sufficient to refute the presumption of market dominance. It has to be proved that it is very likely to exist also in the future. If no substantial competition is evident even in the oligopoly, it is also less likely that it will exist in the relationship to the oligopoly outsiders. The conscious parallelism in the oligopoly could otherwise not be sustained in the long run.

Competition agencies generally prefer to deal with this risk through structural prevention, notably merger control, rather than detailed regulation. Some competition agencies also employ behavioural restraints to reduce the probability of conscious parallelism.

In oligopoly settings, parallel price movements for example could arise simply through independent rational behaviour. To convince courts that parallel behaviour has arisen through some kind of agreement rather than merely resulting from oligopolistic interdependence, competition authorities must usually demonstrate that something more has occurred, i.e. establish the existence of one or more "plus factors". These are basically forms of conduct that would not be economically rational absent some agreement among competitors.

Some competition laws prohibit certain facilitating practices in oligopoly markets even when such practices are not being used in concert with any anti-competitive act. This should be done on a case by case basis since the same general type of practice could both enhance efficiency and facilitate co-ordinated interaction.

When firms know they are highly interdependent, how can competition authorities help ensure they compete instead of find various ways to co-operate? That, in essence, is the “oligopoly problem” confronting competition offices everywhere, especially in markets where collusion is particularly profitable and easy.

The Finnish competition legislation and the commentaries to it display a fairly standard position in dealing with the oligopoly problem. The Finnish Competition Authority has the same legislative tools to tackle the possible oligopoly problem as most other competition authorities in Europe. The Finnish competition legislation covers all three aspects relevant to the oligopoly problem discussed in the paper: tacit collusion, abuse of joint/collective dominance and merger control.
However, the lack of case law implies that tacit collusion or collective dominance seems not to have caused major problems in Finland. In retrospect, it appears that due to structural and institutional factors, the problems involved with explicit collusion and market dominance and the abuse thereof have been more important than the oligopoly problem in Finland. The Finnish Competition Authority has been dealing with a great number of dominance cases and the abuse thereof in the past five years, and now, also, with a relatively high number of merger cases.
Nevertheless, there are many indicators in the Finnish economy, which attest that the oligopoly problem is becoming more relevant. Companies in Finland and in Europe have been reconstructing their strategies through an increasing number of mergers and acquisitions. This would speak for a more sensitive attitude towards the oligopoly problem. Also, the launching of the control of concentrations to Finland adds relevance to the potential market dominance of oligopolistic companies.

Barriers to market entry

High entry barriers to a market as a rule indicate that potential competition is not very important. High barriers to market entry can for example consist of administrative restrictions of market entry (e.g. entry restrictions for environmentally harmful plants or drugs), actual restrictions such as limited resources concentrated only in the hands of the members of the oligopoly, economies of scale in various departments (R&D, production, marketing), a large degree of vertical integration of the members of the oligopoly, exclusive dealing contracts of the oligopoly members with their respective customers, demarcation and concession agreements, industrial standards as well as of high advertising and inter-brand competition in a market. Oligopolies tend to be more contestable in new and dynamically growing markets than in stagnating or declining markets with overcapacities since the former offer greater opportunities to achieve profits.
But this is not the case if certain barriers to market entry exist (patents, licences). If market entry did not occur, or was not successful, in the past despite objectively good opportunities, this may indicate a dominant oligopoly and acts as a deterrent to enterprises that would in principle be interested in entering a market.

Oligopoly theory does indeed have a useful role to play in the investigation of mergers. Correctly applied, oligopoly theory can be useful at identifying the factors which need to be considered in the assessment of a merger e.g. sunk costs, the nature of the product, and the relative efficiencies of firms. However, the report warns that oligopoly theory is of limited use in predicting how a market is likely to behave following a merger. This is in part due to the vast number of competing models and the sensitivity of these models to small changes in assumptions. However, it is also because the structure of the oligopoly, and indeed the nature of competition, is often endogenous and likely to evolve over time.
The report also finds that buyer power is a very important factor in determining the nature of competition in an oligopoly. Buyer power is often neglected in oligopoly models, the standard assumption being that firms sell to individual consumers or, equivalently, a perfectly competitive downstream market. However, the authors find that in most of the case studies where buyer power was present, price competition was strong, either because the buyer was able to play one supplier off against another, or because the they had used their power to affect the market structure (i.e. encouraging entry or integrating backwards). Notably, the only oligopoly where competition did not appear to be effective post-merger was one where no buyer power was present.

The US antitrust laws combat anticompetitive oligopoly behavior in three basic ways. The Sherman Act prohibits horizontal agreements among competitors that restrain trade unreasonably. Section 7 of the Clayton Act prevents mergers or acquisitions whose effect may be to create or strengthen oligopoly structures in markets that are conducive to coordination. And section 5 of the FTC Act prohibits practices that tend to facilitate collusion. Combined, these laws provide a unified approach to dealing with the oligopoly problem.

The concept of oligopolistic dominance generally acknowledged in standard antitrust economics is not primarily founded on the presence of links between their members. In particular standard economic analysis identifies a number of factors which are generally considered relevant for ascertaining the existence of an oligopoly. The presence of links between the members of an alleged oligopoly constitutes simply an additional factor which reinforces the risks of oligopolistic dominance. An oligopoly can thus be proved on the basis of the analysis of the features of the market, even in the absence of structural links between the members of the alleged oligopoly.

BAKER, Jonathan B. (1993) "Two Sherman Act section 1 dilemmas: parallel pricing, the oligopoly problem, and contemporary economic theory", The Antitrust Bulletin, Vol. 38, No. 1 (Spring), pp. 143-219.

MONTI, Giorgio (1996) "Oligopoly: Conspiracy? Joint monopoly? Or Enforceable Competition?", World Competition, Vol. 19, No. 3 (March), pp. 59-102.

NATIONAL ECONOMIC RESEARCH ASSOCIATES (1998) "Merger Appraisal in Oligopolistic Markets" - A Report for the Office of Fair Trading (October).

STIGLER, George J. (1964) “A Theory of Oligopoly”, Journal of Political Economy, Vol. 72. Reprinted as Chapter 5 in The Organization of Industry (Homewood, Ill.: Richard D. Irwin, 1968), pp. 39-63.

Posner, R.A. (1969) “Oligopoly and the Antitrust Laws: A Suggested Approach,” 21 Stanford Law Review 1562.
Stigler, G.J. (1964) “A Theory of Oligopoly,” 72 Journal of Political Economy 44.
Baker, J.B. (1993) “Two Sherman Act Section 1 Dilemmas: Parallel Pricing, the Oligopoly Problem, and Contemporary Economic Theory,” 38 Antitrust Bulletin 143.
Yao, D.A. and S.S. DeSanti (1993) “Game Theory and the Legal Analysis of Tacit Collusion,” 38 Antitrust Bulletin 113.
Posner, R.A. (1976) “Price Fixing and the Oligopoly Problem,” in his Antitrust Law: An Economic Perspective (Chicago, University of Chicago Press).
Jacquemin, A. and M.E. Slade (1989) “Cartels, Collusion, and Horizontal Merger,” in Handbook of Industrial Organization, Vol. 1, eds. R. Schmalensee and R. Willig, (Amsterdam, North-Holland.)
Shapiro, C. (1989) “Theories of Oligopoly Behavior,” in Handbook of Industrial Organization, Vol. 1, eds. R. Schmalensee and R. Willig (Amsterdam, North-Holland). Economic Approaches to Identifying Collusion
Baker, J.B. (1989) “Identifying Cartel Policing Under Uncertainty: The US Steel Industry, 1933-1939,” 32 Journal of Law and Economics S47.
Levenstein, M.C. (1997) “Price Wars and the Stability of Collusion: A Study of the Pre-World War I Bromine Industry,” 45 Journal of Industrial Economics 117.
* Slade, M.E. (1987) “Interfirm Rivalry in a Repeated Game: An Empirical Test of Tacit Collusion,” 35 Journal of Industrial Economics 499.DAFFE/CLP(99)25 245
* Porter, R.H. (1983) “A Study of Cartel Stability: The Joint Executive Committee, 1880- 1886,” 14 Bell Journal of Economics 301. Factors That Tend to Complicate Collusion Theory
Shughart, W.F. (1997) “Oligopoly and Collusive Behavior” and “Coordinating Oligopolistic Activity” in his The Organization of Industry (Houston, Dame).
Carlton, D.W. and J.M. Perloff (1994) “Cartels: Oligopoly Joint Decision Making” in their Modern Industrial Organization (New York, Harper Collins).
Scherer, F.M. And D. Ross (1990) “Conditions Facilitating Oligopolistic Coordination” and “Conditions Limiting Oligopolistic Coordination” in their Industrial Market Structure and Economic Performance (New York, Houghton Mifflin).
* Selten, R. (1973) “A Simple Model of Imperfect Competition, Where 4 Are Few and 6 Are Many,” 2 International Journal of Game Theory 141.
* Werden, G.J. and M.G. Baumann (1986) “A Simple Model of Imperfect Competition in Which Four Are Few But Three Are Not,” 34 Journal of Industrial Economics 331. Empirical Evidence
Posner, R.A. (1970) “A Statistical Study of Antitrust Enforcement,” 13 Journal of Law and Economics 365.
Asch, P. and J. J. Seneca (1976) “Is Collusion Profitable?,” 68 Review of Economics and Statistics 1.
Eckbo, P.L. (1976) “The Experience of Previous International Commodity Cartels,” in his The Future of World Oil (Cambridge, Ballinger).
Asch, P. and J.J. Seneca (1975) “Characteristics of Collusive Firms,” 23 Journal of Industrial Economics 223.
Dick, A.R. (1996) “When Are Cartels Stable Contracts?,” 39 Journal of Law and Economics 241.
Dick, A.R. (1997) “If Cartels Were Legal, Would Firms Fix Prices?,” Unpublished paper.
Fraas, G.A. and D.F. Greer (1977) “Market Structure and Price Collusion: An Empirical Analysis,” 26 Journal of Industrial Economics 21.
Hay, G.A. and D. Kelley (1974) “An Empirical Survey of Price Fixing Conspiracies,” 17 Journal of Law and Economics 13.
 

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