SKOPJE, Macedonia, July 11 (UPI) -- In the real world, tacit and implicit understandings regarding prices and competitive behavior prevail among competitors within oligopolies. Establishing a reputation for collusive predatory pricing deters potential entrants. And a dominant position in one market can be leveraged into another, connected or derivative, market.
However, not everyone agrees. Ellis Hawley believed that industries should be encouraged to grow because only size guarantees survival, lower prices, and innovation. Louis Galambos, a business historian at Johns Hopkins University, published a 1994 paper titled "The Triumph of Oligopoly." In it, he strove to explain why firms and managers -- and even consumers -- prefer oligopolies to both monopolies and completely free markets with numerous entrants.
Oligopolies, as opposed to monopolies, attract less attention from trustbusters. Quoted in The Wall Street Journal on March 8, 1999, Galambos wrote: "Oligopolistic competition proved to be beneficial ... because it prevented ossification, ensuring that managements would keep their organizations innovative and efficient over the long run."
In his recently published tome "The Free-Market Innovation Machine -- Analyzing the Growth Miracle of Capitalism," William Baumol of Princeton University, concurs. He daringly argues that productive innovation is at its most prolific and qualitative in oligopolistic markets. Because firms in an oligopoly characteristically charge above-equilibrium (i.e., high) prices, the only way to compete is through product differentiation. This is achieved by constant innovation -- and by incessant advertising.
Baumol maintains that oligopolies are the real engines of growth and higher living standards and urges antitrust authorities to leave them be. Lower regulatory costs, economies of scale and of scope, excess profits due to the ability to set prices in a less competitive market -- all allow firms in an oligopoly to invest heavily in research and development. A new drug costs about $800 million to develop and get approved, according to Joseph DiMasi of Tufts University's Center for the Study of Drug Development, quoted in The Wall Street Journal.
In a paper titled "If Cartels Were Legal, Would Firms Fix Prices?" published by the Antitrust Division of the U.S. Department of Justice in 1997, Andrew Dick demonstrated, counterintuitively, that cartels are more likely to form in industries and sectors with many producers. The more concentrated the industry -- i.e., the more oligopolistic it is -- the less likely were cartels to emerge.
Cartels are conceived in order to cut members' costs of sales. Small firms are motivated to pool their purchasing and thus secure discounts. Dick draws attention to a paradox: mergers provoke the competitors of the merging firms to complain. Why do they act this way?
Mergers and acquisitions enhance market concentration. According to conventional wisdom, the more concentrated the industry, the higher the prices every producer or supplier can charge. Why would anyone complain about being able to raise prices in a post-merger market?
Apparently, conventional wisdom is wrong. Market concentration leads to price wars, to the great benefit of the consumer. This is why firms find the mergers and acquisitions of their competitors worrisome. America's soft drink market is ruled by two firms -- Pepsi and Coca-Cola. Yet, it has been the scene of ferocious price competition for decades.
"The Economist," in its review of the paper, summed it up neatly: "The story of America's export cartels suggests that when firms decide to co-operate, rather than compete, they do not always have price increases in mind. Sometimes, they get together simply in order to cut costs, which can be of benefit to consumers."
The very atom of antitrust thinking -- the firm -- has changed in the last two decades. No longer hierarchical and rigid, business resembles self-assembling, nimble, ad-hoc networks of entrepreneurship superimposed on ever-shifting product groups and profit and loss centers.
Competition used to be extraneous to the firm -- now it is commonly an internal affair among autonomous units within a loose overall structure. This is how "Neutron Jack" Welch deliberately structured General Electric. AOL Time Warner hosts many competing units, yet no one ever instructs them either to curb this internecine competition, to stop cannibalizing each other, or to start collaborating synergistically. The few mammoth agencies that rule the world of advertising now host a clutch of creative boutiques comfortably ensconced behind Chinese walls. Such outfits often manage the accounts of competitors under the same corporate umbrella.
Most firms act as intermediaries. They consume inputs, process them, and sell them as inputs to other firms. Thus, many firms are concomitantly consumers, producers, and suppliers. In a paper published last year and titled "Productive Differentiation in Successive Vertical Oligopolies", that authors studied: "An oligopoly model with two brands. Each downstream firm chooses one brand to sell on a final market. The upstream firms specialize in the production of one input specifically designed for the production of one brand, but they also produce he input for the other brand at an extra cost. (They concluded that) when more downstream brands choose one brand, more upstream firms will specialize in the input specific to that brand, and vice versa. Hence, multiple equilibria are possible and the softening effect of brand differentiation on competition might not be strong enough to induce maximal differentiation" (and, thus, minimal competition).
Both scholars and laymen often mix their terms. Competition does not necessarily translate either to variety or to lower prices. Many consumers are turned off by too much choice. Lower prices sometimes deter competition and new entrants. A multiplicity of vendors, retail outlets, producers, or suppliers does not always foster competition. And many products have umpteen substitutes. Consider films -- cable TV, satellite, the Internet, cinemas, video rental shops, all offer the same service: visual content delivery.
And then there is the issue of technological standards. It is incalculably easier to adopt a single worldwide or industry-wide standard in an oligopolistic environment. Standards are known to decrease prices by cutting down R&D expenditures and systematizing components.
Or, take innovation. It is used not only to differentiate one's products from the competitors', but to introduce new generations and classes of products. Only firms with a dominant market share have both the incentive and the wherewithal to invest in R&D and in subsequent branding and marketing.
However, oligopolies in deregulated markets have sometimes substituted price fixing, extended intellectual property rights, and competitive restraint for market regulation. Still, Schumpeter believed in the faculty of "disruptive technologies" and "destructive creation" to check the power of oligopolies to set extortionate prices, lower customer care standards, or inhibit competition.
Linux threatens Windows. Opera nibbles at Microsoft's Internet Explorer. Amazon drubbed traditional booksellers. eBay thrashes Amazon. Bell was forced by Covad Communications to implement its own technology, the DSL broadband phone line.
Barring criminal behavior, there is little that oligopolies can do to defend themselves against these forces. They can acquire innovative firms, intellectual property, and talent. They can form strategic partnerships. But the supply of innovators and new technologies is infinite -- and the resources of oligopolies, however mighty, are finite. The market is stronger than any of its participants, regardless of the hubris of some, or the paranoia of others.
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