- 1. Oligopolistic Market Structure
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- 2. Concentrated Market
- 3. Oligopolistic Industry
- 4. Relevant Product Market
- 5. Market Consolidation
- 6. Strategic Behaviors and Mutual Interdependence
- 8. Calculation of the HHI
- 9. How the Government Uses the HHI in Analyzing Proposed Mergers
- 10. Why the Government Denied the 2010 AT&T and T-Mobile Merger
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1. Oligopolistic Market Structure
The oligopolistic market structure is the one where a few market players are dominant. Such companies may be the only ones in the market; however, it is also possible for other small firms to operate in the market. Oligopolistic market structures have several characteristics, the most common of which is the number of companies. According to Collins (2009), in oligopoly, one firm’s decision has a direct impact on the rest of the companies. The first feature of oligopoly leads to the next characteristic which Collins (2009) names as the mutual interdependence of companies. Thus, it means that before one makes a decision, it should inquire about the reaction of other players so that it does not end up at a strategic disadvantage.
The third characteristic of firms in the oligopolistic market is their strategic behavior. In most of the cases, none of the companies in an oligopoly has a significant market advantage over other large firms. As such, they have to keep strategizing on how to beat their competitors in the market (Collins, 2009). The strategic behavior includes the decisions on product differentiation, as well as raising or lowering the prices of goods or creative marketing.
The fourth characteristic of the oligopolistic market structure is the barriers that large companies create to prevent small businesses from entering the market (Collins, 2009). Such barriers are possible as companies have a strategic advantage over newer and smaller players in the market, such as superior knowledge of the market. This way, dominant companies will seek to control the market and exclude smaller firms through methods such as monopolizing scarce resources in the market. Smaller companies with little or no possession of these limited resources will be frustrated upon entering such a market because they will ultimately find it impossible to operate since they will continuously make losses while facing competitive assaults of larger firms.
Due to the domination of a few firms, the coordination between them is a usual notion. As such, they can benefit through the formation of cartels, which is their fifth distinguishing feature. After the formation of a cartel, they seek to operate as a monopoly (Collins, 2009). This way, companies can control the market in unison in aspects such as the setting of prices. This price collusion can be either formal or informal. The Organization of Petroleum Exporting Countries (OPEC) can serve an example of such formal collusions. The OPEC is made up of the countries with the biggest petroleum resources in the world and it sets out the price of the oil in the international market.
The next feature of the oligopolistic structure is the nature of firms’ products (Collins, 2009). The products companies sell could be similar, for instance, laptops, or perform the same function but be marginally different like various types of motor vehicles, for instance, station wagons and saloon cars. Thus, advertising becomes essential in a bid to be more successful than competitors.
The last feature of oligopolistic market structures is that market players are usually setting the prices rather than operating under the prices that have been set by the market forces. Their dominance makes it possible for them to set processes accepted and used by all players in the market. For instance, OPEC dictates the global petroleum prices.
2. Concentrated Market
A concentrated maret is the one that has a few firms which control a disproportionately large percentage of the market and make it impossible for other firms to penetrate the market. In the concentrated market, a few dominant firms exercise mutual interdependence and strategic behavior (Collins, 2009).
3. Oligopolistic Industry
For an industry to be oligopolistic, there should be a few firms in the market which control the major segment of the market and, as such, set prices that are uniform in the industry. Due to a few firms being dominant, the industry will lack competition in the end because firms that are not dominant in the industry will face formidable barriers to break into the market and be competitive (Collins, 2009).
4. Relevant Product Market
A relevant product market is the one made up of goods or services that can be alternated or changed by a buyer because of the products’ utility, features, or price (Carlton, 2007). The identification of these products and services in the market is important because the knowledge can be used to determine which products to include in the market (Carlton, 2007).
5. Market Consolidation
A competitive market usually comprises several players in it. However, as the market grows, the stakes become bigger. As such, the market becomes structured through processes such as consolidation (Clarkson, Miller, & Cross, 2010, p. 797). Market consolidation occurs when larger companies take over smaller ones to increase their market share (Clarkson, Miller, & Cross, 2010, p. 797). In addition to the acquisition of one company by another, consolidation can also occur through the merger of two or more firms. Where consolidation occurs through the acquisition of a financially weaker firm by a larger one, it is called a building scale.
6. Strategic Behaviors and Mutual Interdependence
Strategic behavior occurs because in an oligopoly, there is no single clear market leader but a few firms that have significant market share and a mutual interdependence. As such, companies have to seek maneuvers through strategic behavior to be competitive and gain a market advantage over their competitors. Strategic behavior includes measures such as product differentiation so that consumers can clearly know products of a particular company (Collins, 2009).
Mutual interdependence means that companies depend on one another to such an extent that the action of one of them will have a ripple effect on the market. Thus, firms are unable to make a decision independent of one another and they have not only to monitor the decisions of other firms but also anticipate their reaction towards other decisions the company might take (Collins, 2009).
7. Herfindahl-Hirschman Index (HHI)
HHI is an index that measures the concentration of firms in the market. Additionally, it tracks the changes in the depth of their concentration in case of mergers between firms in a market (McAfee & Lewis, 2009, p. 5). A higher index indicates a more concentrated market while a smaller ratio indicates a less concentrated market. The intensity of the competitive market can also be measured using the index in an industry or a market. If the market is extremely concentrated, then it is an indication that there exists little or no competition in the market (McAfee & Lewis, 2009, p. 8).
8. Calculation of the HHI
To get the value of the HHI in a particular market, one squares each value of the percentage of the market value of the shares of all firms in the market (McAfee & Lewis, 2009). One then sums up the values of the consequential square values they obtain from the initial step. According to the Horizontal Merger Guidelines by US Department of Justice & Federal Trade Commission (2010), an HHI below 1500 points indicates an unconcentrated market. If the value is between 1500 and 2500, the market is fairly concentrated. If the value is more than 2500 HHI, then the market is very concentrated (McAfee & Lewis, 2009, p. 6).
9. How the Government Uses the HHI in Analyzing Proposed Mergers
The Federal Government through the Department of Justice has the duty to appraise mergers. Both Federal and State Governments provide that firms worth more than $50 million in assets, which are planning a merger with other companies, must file a request to the government (McAfee & Lewis, 2009, p. 5). The government then analyzes the proposed merger and decides whether to endorse or sue it if the merger is the violation of the antitrust law. The Department of Justice & Federal Trade Commission (2010) Horizontal Merger Guidelines are the tool the government uses to do the analysis as they explain whether the merger will significantly affect competition in a market by making it more uncompetitive. In moderately concentrated and extremely concentrated markets, if the HHI raises by more than 100 and 200 points, respectively, it will raise concerns. Usually, a merger that will produce a post-merger HHI of more than 2500 points is rejected (McAfee & Lewis, 2009, p. 6).
10. Why the Government Denied the 2010 AT&T and T-Mobile Merger
A merger is horizontal if the two firms which are about to merge compete at the same level in the same market. The merger of AT&T and T-Mobile would have created an HHI of 3,335 points, an increment of 951 in New York. In Chicago, the increase would have been from 1,114 points to 3,189 points (Stewart, 2013). Thus, the HHI of the merger would have been way above the Department of Justice & Federal Trade Commission (2010) guidelines on horizontal mergers. The government opined that the merger would kill competition in the wireless service manufacture industry (Stewart, 2013). The merger was also above the recommended 200 points (Stewart, 2013). Furthermore, if the government had allowed the merger, it would have been extremely hard for other firms to penetrate and stay in the market. This lack of competition due to the dominance of the industrial hegemon that would have been created by the merger would have allowed the new company to set the prices. The high prices would have led to products that would have been expensive for the consumer. Lastly, with other companies unable to break into the market, innovation and creativity would dry from the industries.
11. Oligopolistic Industry in the U.S.
The breakfast cereal manufacturers in the USA are a form of oligopoly. General Mills and Kellogg’s have dominated the ready-to-eat cereals for a long time (Rittenberg & Tregarthen, 2011). The U.S. Census Bureau found out that the HHI in the market was 2521 which is extremely concentrated according to the Department of Justice & Federal Trade Commission (2010) guidelines. The two firms thus hold the bulk of the market and can set prices of the products, meaning that for a long time, it has been impossible for new firms to enter the market.
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