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Oligopoly – definition and meaning

An oligopoly is a market sector in which very few firms compete or dominate. It is a highly concentrated market. It does not mean there are just two, three or four competitors. In fact, there could be dozens of them. However, there are only a few dominant ones.

For example, let’s suppose a market has fifty competitors. However, the top three dominate 90% of the market. That market is an oligopoly.

Do not confuse the term with oligopsony, which is a market with few buyers and many sellers.

The dominant players in an oligopoly often work together. In other words, they collude. They collude as if they were a single monopoly, and try to fix minimum prices. They also try to fix output volumes and other terms of business.

Sometimes, the oligopolists opt for non-price competition – where their prices stay the same, and they compete using other factors. Perhaps they compete in packaging, customer service, or special delivery options. In these cases, their aim is to avoid a cut-throat price war.

Oligopoly features
When there is an oligopoly, the dominant players collude. They try to make it very hard for new companies to enter the market. In fact, their behaviors are quasi-monopolistic. They keep their prices artificially high, pursue non-price competition strategies and seek out merger and acquisition opportunities. They do everything they can to maintain their status quo.

Oligopoly – collusion

Companies in oligopolies frequently collude in an attempt to stabilize a market that is unstable. Thyy do this to minimize the risks inherent in these markets for product development and investment. In most countries, there are legal restrictions on such collusion.

For a firm to be colluding illegally, the authorities must catch it communicating with a rival. In many cases, there is no formal or observable collusion taking place.

According to the Financial Times Lexicon, an oligopoly is:

“When supply of a particular product is dominated by a few companies, which are therefore able to control prices and output – though they would normally have to take each other’s decisions into account.”

Sometimes, a market becomes an oligopoly because the dominant players collude to minimize competition. For example, they manipulate prices and raise barriers to entry.

Oligopoly quote - John Galbraith
John Kenneth Galbraith  (1908–2006) was a Canadian-American economist, diplomat and public official. He was also a leading proponent of 20th century American liberalism. He was a supporter of Post-Keynesian economics from an institutionalist perspective. (Image: Wikipedia)

In the majority of oligopolies, each dominant rival is aware of what every player is doing. They are aware because there are so few of them. Therefore, keeping an eye on each other is relatively easy.

Game theory states that the decisions of one major player in an oligopoly influences all the others’ decisions. It also works the other way round.

When an oligopolist is considering planning and strategy, it must take into account how its rivals are likely to respond.

Oligopoly – examples

The United States

Movie Studios: there are hundreds of them across the country. However, eighty-seven percent of all film revenues come from just six dominant players.

TV and Fast Internet: seven firms dominate nearly the whole US market. The seven companies are Comcast, Viacom, CBS Corporation, News Corporation, and the Walt Disney Company.

Mobile Phone Communications: – eighty-nine percent of the market is controlled by just four wireless providers. The providers are AT&T Mobility, Verizon Wireless, Sprint Nextel and T-Mobile.

The United Kingdom

Supermarket Chains: four companies – Morrisons, Sainsbury’s, Asda and Tesco – control 74.4% of the grocery market.

High-Street Banks: this sector is dominated by Natwest, Lloyds, Santander, Barclays, and HSBC.

Detergent Market: this is a duopoly. In other words, there are just two major suppliers. The suppliers are Unilever and Procter & Gamble. The two multinationals control more than four-fifths of the nation’s detergent market.

Electricity Distribution: EDF Energy, Centrica, RWE npower, Scottish Power, E.on, Scottish and Southern Energy (SSE) control 95% of the market.

The World

Oligopolies do not exist just within countries, but also in whole continents and across the globe.

Globally, there are three dominant computer operating systems – Linux, Mac OS and Windows. They control virtually the whole desktop computer market.

In the smartphone and tablet markets, Google Android and Apple iOS together have more than 90% global market share.

Oligopoly – Herfindahl-Hirschman Index

The Herfindahl-Hirschman (HHI) Index or Herfindahl Index measures the extent to which market share is controlled by a few or many competitors. The Index measures the market concentration of the fifty largest companies in an industry. The Index aims to determine whether there is healthy competition or imperfect competition in that sector.

We calculate the HHI by squaring the market share of each player and summing the resulting numbers. For example, if there are four competitors with market shares of 30, 30, 20 and 20 percent, the HHI is 2,600 (the sum of 302 plus 302 plus 202 plus 202).

The HHI score can range from very near zero – more than 100 similar-sized competitors – to 10,000 – a monopoly.

A monopoly has 100% share of the market: 1002 = 10,000. A market with 100 competitors of similar size would be calculated as follows: 12 x 100 = 100. The larger the score, the more imperfect a market is.

Regarding the HHI scores and how US agencies rate them, the Department of Justice says:

“The agencies generally consider markets in which the HHI is between 1,500 and 2,500 points to be moderately concentrated, and consider markets in which the HHI is in excess of 2,500 points to be highly concentrated.”

 

Video – Game theory and Oligopoly

In this Crash Course video, Jacob and Adriene tell us what oligopolies are.