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Identify and Explain the Key Features of an Oligopolistic Industry. Illustrate Your Answer with Reference to an Industry of Your Choice.

In: Business and Management

Submitted By rajeevramrekha
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Introduction The first section of this report outlines the key features and characteristics of an oligopolistic market structure. An oligopoly market structure can be differentiated from others because it has distinct features such as competition among a few firms, high concentration ratio and barriers to entry, non price competition, differentiated products and high level of interdependence between firms. The report also outlines and describes why the UK detergent industry which is dominated by a few firms reflects the model of an oligopoly. Several real life examples have been used to confirm the theory of oligopoly. Moreover, the price rigidity observed in an oligopolistic industry has been explained by the kind demand curve theory. The second section of the report examines the case of price fixing by Procter & Gamble, Unilever and Henkel, who are major players in the detergent industry in Europe. It relates the concept of collusion and how it has led the firms to price fixing arrangements in the detergent industry. Finally the economic rationale why Henkel was not fined by the European Competition Commission has been discussed.

Market structures may be generally categorised as the following: perfect competition, monopoly, oligopoly or monopolistic competition. These different types of market structures can be differentiated mainly by the number of competitors in a market and their market share.
An oligopoly is a form of market structure that has few sellers that dominate the industry and they tend to sell differentiated products. It is also one of the most predominant market structures in the business world.

One industry which is likely to be classified as an oligopolistic is the grocery industry in the UK. This industry is dominated by four main players, namely Tesco, Asda, Sainsbury’s and Morrisons. The 4-firm concentration ratio is around 76.4% (BBC News, 2011) and illustrates that the industry has oligopolistic characteristics because of a significant market share.

It can be argued that the high concentration ratio of these firms is partly due to the high entry barriers into this industry. In the grocery industry, the minimum efficient scale is high and this can act as a natural barrier. Moreover, the dominating four firms are fully capable of supporting the market size in the UK which makes it difficult for new entrants to enter the market. Large firms in an oligopolistic structure usually enjoy huge economies of scales. They are able to keep product prices low and highly competitive due to the fact that they produce huge quantities of a particular product.
The takeover of Safeway by Morisson was a strategic move to increase the latter’s market power. Thus it can be reasonably argued that Morrisson has achieved greater economies of scale, which makes it difficult for smaller firms to compete. Moreover, Morrison’s brand loyalty would also increase because they would attract Safeway’s customers. This would be an example of a strategic entry barrier in the sense that new entrants have to invest massively in brand names, advertising and marketing to be able to enter the market successfully. As such, smaller firms are discouraged to enter the market because of the high sunk costs associated.

Another distinct feature of an oligopoly is that firms are highly interdependent. In other words, each firm must consider the likely response of other rival firms when making pricing and investment decisions. According to Gordon (2011), the market leader Tesco has launched a series of price cuts which forced other supermarkets to react. As such, Morrison has also deepened its own price cuts due to promotions set by competitors.
Moreover, Sainsbury has recently announced that it will match the prices of certain products set by its rivals Tesco and Asda (BBC Business News, 2011). The strategic move by Sainsbury to this price matching scheme comes shortly after Tesco launched its own price drop promotion. Customers would be offered coupons to match the price of goods if they found the same items being sold at a lower price at the rival supermarkets. Thus it can be argued that the firms are fully aware of the effects of monitoring competitors’ behaviour and consequently making their own economic decisions. As supermarkets operate within an oligopoly market, price tends to remain rigid. The stability of the market price can be explained by the kinked demand curve which is illustrated in Figure 1.

Figure 1: The Kinked Demand Curve

When a firm increases its product price from P1 to P2, there is a substantial decrease in demand from Q1 to Q2. Therefore, the firm would most likely suffer a drop in its market share because of price elasticity. Moreover, rival firms are unlikely to follow same. It is important to note that only customers, especially older people with strong brand loyalty will remain in this case.
However, if the firm decreases its product price from P1 to P3, demand will increase. Hence rival firms are more likely to decrease their product price so as not to lose their market share. This can be explained by the above example of Sainsbury price matching scheme. Therefore the price is most likely to set at point X (the equilibrium point) and remains rigid once it has been established.

Sweezy (1939) argued that firms under oligopoly prefer not to engage in price competition. As a consequence, firms prefer to compete in non price competition to increase their market share and profits. Supermarkets use various strategies such as advertising, marketing, issue of loyalty cards, internet shopping for customers, extension of opening hours, home delivery systems etc to compete with their rivals. For instance, Tesco had first introduced the loyalty Clubcard in 1995 and a year later, Clubcard holders were spending 28% more at Tesco and 16% less at Sainsbury's (Trench, 2010).

This supports the fact that non price competition is more likely to occur in oligopolistic industries and is an important aspect for the battle of sales.…...

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