An oligopoly represents a type of market where only a couple of companies dominate the majority of market share. As only a few firms share markets between them, they are called highly concentrated. Even though just several firms are dominant, numerous smaller companies can also compete in such a market. Major national airline carriers like British Airways and KLM-Air France may dominate their routes and have only a handful of major competitors. There are still numerous smaller airline travel operators that provide trips and special services within the market.
Economists like to identify such an oligopoly by focusing on its concentration ratio. These determine the percentage of aggregate market share which only a few companies control. If high concentration is present in such an industry or market segment, economists will call these industries oligopolies. When such oligopolies merge together, the concentration becomes even higher. It makes monopoly control even more likely. This is why regulators in developed countries review such mergers to investigate their impact on market share and control.
There are several main characteristics that effectively describe the conditions which exist in an oligopoly market. These include interdependence, common strategy, and barriers to entry. Oligopoly companies are interdependent on each other. Such corporations that have only a handful of effective competitors have to consider their near rivals reaction when they engage in their own decisions. If an oil company wanted to gain market share through price reductions, it would have to contemplate how its rivals would similarly lower their prices in response.
Oligopoly companies’ strategies are related to this interdependence idea. These firms have to predict how their rivals will respond to their price changes or other activities which are not price related. They must establish plans which take into consideration the options they will use based on how their rivals retaliate. This means that oligopolies’ members have to decide whether they will collude with their rivals or compete with them.
They also have to decide whether to make any industry leading decisions or simply react to those their rivals make. This is the distinction between a first mover and second mover posture. First movers may gain the advantage of profits from a head start. Second movers have the benefit of waiting to see how their close rival’s strategies work out before attempting to counter them or improve on the ideas.
The barriers to entry in an industry are a key component of why oligopolies exist in the first place. Such companies can dominate the market segment simply because it is so hard and expensive for new rivals to begin operating within the market. These barriers to entry might be natural or they could be artificially erected by the dominant firms to maintain their positions.
Among the main natural to entry barriers in oligopoly industries are economies of large scale, control of scarce resources, high start up costs, and high research and development costs. Some markets require large economies of scale in order for a company to be price competitive. This keeps out new participants if the existing companies have taken advantage of them.
High start up and high research and development costs mean that new companies will take a long time to become profitable. A number of these costs can not be recovered if a firm decides to abandon the market. Besides R&D, this includes advertising, marketing, and other costs which are fixed. Firms which wish to become involved in research and development intensive industries will require enormous financial reserves so that they can outspend the established oligopoly members.