Characteristics of an Oligopolistic Market Structure
An oligopolistic market structure is a structure, in which only a few large companies are dominant. These firms may be the only ones in the market or at times there may also be other small businesses. The first and foremost common characteristic of this market structure lies in the number of firms in the market. There are not so many companies, but they have a large capacity. Being few in the market makes it possible for one company's decisions to affect the other firms. The second characteristic of this market is that the companies exercise mutual interdependence. As just a few companies are present when a firm makes a choice it is bound to affect the rest of the companies in the marketplace. For this reason, companies are dependent on each other. Before making its decisions, a company must inquire about the reaction of its neighbors. On their part, the neighboring firms have to keep strategizing on how to beat their competitors in the market. Strategic behavior is the third characteristic of the oligopolistic market structure. Firms have to keep on strategizing on how to outshine the competition as the companies are interdependent. The strategic behaviors that businesses exercise may include decisions on increasing the prices for their products or embarking on creative marketing like product differentiation.
The fourth distinguishing factor of this market structure is its various barriers to entry created by the few large companies to prevent small firms from entering the market. Oligopolies always consist of a few companies dominating the entire market. These companies enact barriers such as owning scarce resources or having the superior knowledge of the market. Small businesses that are new in the market and have no possession of these limited resources would be frustrated upon entering such a market as they would end up experiencing losses. Formation of cartels and collusions is the fifth characteristic of the oligopolistic market structure. Most of the time, firms in this structure join forces to act as a monopoly. This way the companies can control the market in ventures such as setting the prices of products and services. An example of collusion would be an organization formed to control oil issues especially the setting of global oil prices. The sixth characteristic of the market structure is in the nature of their products. The companies in an oligopolistic market structure may be selling the same products such as aluminum sheets. The firms may also be selling differentiated products like various models of automobiles. For the companies that sell differentiated products, advertising is essential. The firms have to exercise strategic behavior and be creative to outshine their rivals. The seventh and most common characteristic of oligopolies is that they are price setters. The firms in this market structure are known to set prices rather than to use prices that are already set. Being few, large and dominant in the market structure makes it possible for them to set prices that are to be accepted and used by everyone. An example of a price setter is OPEC that is famous for setting global fuel prices.
A concentrated market is a market consisting of a few firms. These companies control a large share of the market. A number of businesses existing in a concentrated market dominate it and makes it impossible for other companies to enter the market. The firms in a concentrated market are known to practice mutual interdependence and strategic behavior.
An Oligopolistic Industry
An industry is considered an oligopoly when there are only a few firms in the industry. These companies control the majority of shares of the whole industry. They set up the prices that affect the industry. The industry ends up with a lack of competition as other firms are locked out of it due to the formidable barriers to enter the industry.
Relevant Product Market
The relevant product market is made of goods and services that can be alternated or changed by a customer according to the products’ or services’ cost, value, and features. The identification of these products and services in the market is essential as it helps to gain knowledge on all of the products and services that are competing in the market. Once identified, these products are to be included in the same market.
A standard competitive market always starts with a few players in it. However, as the market grows, it has to get structured through such processes as consolidation. Market consolidation is the takeover of companies that are considered small in the market by large firms. These companies consolidate to serve the market efficiently. A market consolidates by means of the firms existing in it. The consolidation can occur either through a merger of the companies or an acquisition of one company by another one. The acquisition is also known as building scale where a financially secure company purchases a financially weak firm. As for the mergers, it means that the two companies become a single one which makes them stronger and a more competitive force in the market.
Strategic Behavior and Mutual Interdependence
Strategic behavior is a concept arising in oligopolistic market structures. Strategic behavior in firms occurs because of the mutual interdependence that exists among the firms in the market. As the companies depend on each other, they need to strategize on how to beat their rivals to survive in the market. The strategic behaviors that the companies can embark on include enacting pricing decisions or product differentiation measures that will help them beat the competitors.
Mutual interdependence also occurs in oligopolistic market structures. In this respect, one company's deeds such as the setting of prices for its products have a noticeable effect on its competitors. The firms cannot operate independently from each other. They need to monitor their competitor's actions and their effect on their functions.
The index measures the concentration of the firms in the market. It also tracks the changes in the concentration of firms upon entering into mergers. The larger the index, the more concentrated the market is. The smaller the ratio, the less concentrated the market would be. The index also helps to recognize the intensity of the competitive environment that subsists within a market or industry. An extremely concentrated market implies that there is little or no competition in the market
Calculation of the Herfindahl-Hirschman Index
To calculate the HHI, one should square each value of the percentage of the shares and market values of all the firms in the market. The consequential square values are then summed up. According to the U.S. Department of Justice-Federal Trade Commission 2010 Horizontal Merger Guidelines, when the HHI is below 1500 points, the market is considered low-concentrated. An HHI of between 1500 and 2500 translates to the market being fairly concentrated. The market is said to be extremely concentrated when the index is above 2500 points.
How the Government uses HHI in Analyzing Proposed Mergers
The U.S. Justice Department fulfills duty of appraising mergers. The federal and national governments necessitate the firms with more than $50 million in assets, which plan to merge with other companies, to file their request with the government. The government then embarks on analyzing the merger and decides on whether to endorse it or sue to obstruct it as a violation of one of the antitrust regulations. In analyzing the proposed mergers, the government uses the Department of Justice-Federal Trade Commission 2010 Horizontal Merger Guidelines. These guidelines explain whether a merger would affect the competition in a market. A merger will raise essential competitive concerns if it produces an increase of more than 100 points of HHI in a market that is considered moderately concentrated. In an extremely concentrated market, a merger that produces an increment of 200 points will also raise concerns. The two departments in charge of merger analysis will scrutinize a merger in an industry with an HHI of between 1500 and 2500 after the merger. They will categorically reject the merger request if its HHI is more than 2500 points.
Reasons for Government Denial of the 2010 AT& T and T-Mobile Merger
The merger between the two companies would be a horizontal merger as they are on the same level and compete in the same market to offer similar services. In the merger agreement, AT & T agreed to advance T-Mobile with a huge disintegration payment of $ 3 billion in cash, a wireless band, and a roaming accord of an extra $3 billion if the deal were to survive the antitrust law's testing. The government evaluated the effect of the agreement in various cities. In New York, the merger between the two companies would create an HHI of 3,335 points with an increase of 951. In Chicago, the resultant HHI would be 3,189 points with an increase of 1,114 points.
The HHI of the merger of the two firms was above the required levels as outlined in the Department of Justice-FTC 2010 Horizontal Merger Guidelines. According to the regulations, any industry concentration with intensity higher than 2500 points is considered unacceptable. It was, therefore, clear to the government that the merger would eliminate competition from other wireless service manufacturers in the industry. The merger increases were also way above the required 200 points. Had the government permitted the merger, other firms would not have been able to enter the market. The lack of competition as a result of the two firms owning the majority of the wireless market would imply that the two companies would set the prices for the services in the whole industry. If the set prices are high, it would affect consumers who would be unable to afford the services. The merger would also disable innovation and creativity from other companies. These firms would be unable to enter the industry.
Oligopolistic Industry in the US
An example of an oligopolistic industry is the breakfast cereal industry that manufactures ready-to-consume products. General Mills and Kellogs companies dominate the industry. In a survey conducted by the U.S. Census Bureau, the HHI of the market in this industry was 2521points. According to the DOJ-FTC 2010 Merger Guidelines, an HHI of above 2500 points is considered extremely concentrated. The implication of the HHI suggests that the two companies hold the bulk of the market power of the industry. They control the prices in the industry by setting the prices. Consequently, other firms would be unable to compete with them in the industry. It is because the two companies set entry barriers that other new entrants to the market are unable to penetrate.