Oligopoly

Team M.I.
OLIGOPOLY
INTRODUCTION
In a viewpoint of real-world existing markets, where conditions allow firms to
have the capacity to influence or even instigate control of production pricing, imperfect
competition exists. One such market model, which will be discussed in this paper, is
Oligopoly.
An Oligopolistic Market is an archetype of an imperfect competition where only a
few firms in a certain industry hold the capability to influence market pricing. These
firms, which produce either standardized or differentiated commodities, in theory have
primary control of particular product markets. Yet the complexity ascribed to the
relationship of these producers of the industry can be greatly varied. Owing to a big
market share of oligopolists, a decision or strategic action of one affects the behaviour
of the other firms and vice versa.
Pricing of commodities, as well as the development of new products, not to
mention non-price strategic endeavours lead to a fiercely fought market share.
In the Philippines, numerous industries resemble a market of oligopoly. Television
broadcast stations, for one, limit consumers, or the audience, to dial the numbers - two,
five or seven, in their television remote controls. Pricing of petroleum too, are greatly
influenced by none other than the Big Three. Even carbonated drinks are controlled by
only two - Pepsi and Coke.
Competition of these companies in an oligopoly can be tight. It brings about a
more competitive pricing level and often than not, better quality of production to benefit
the end-users, better known as the consumers or the households. Taking to account the
movements of their competitors, and how their own companies could best compete
given these factors, oligopolistic firms are constrained to limit high profits in order to
protect market share. In the end, each firm will decide to perform its best given what its
competitors are doing.
The question in oligopolistic competition is whether these firms would cooperate
with each other, explicitly or tacitly, and manipulate price and production, or decide to
compete to achieve maximum profit in the particular industry.

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THE FIVE-FORCES MODEL
To better understand the complex strategies of competition in an Oligopolistic
Market, the Five-Forces Model is used in standard. This model helps us recognize the
inter-relationship of the different forces affecting the firms in an oligopoly, and their
relative profitability given the extent of these forces.
The Five-Forces Model
Potential entrants to
the Industry

Suppliers

INDUSTRY
COMPETITORS

Buyers

Substitutes

At the center of the model are the firms directly or indirectly competing for market
share in the industry. Being in an oligopolistic market, greater concentration is on
thinking about what the other companies are and will be doing and how each could
compete given the actions of their competitors.
Additional concern for these existing firms is the possible entry of companies in
the industry for this could mean a diminished market share for those in the oligopoly. A
threat of potential entrants could lead to an industry behaving like a perfectly
competitive market where no single seller could have a significant impact in pricing. In
markets where there is ease of entry and exit of firms, potential entry could bring about
a more competitive pricing level. Also called contestable markets, prices are pushed to
long-run average costs and the previously high profits are minimized.
Barriers to Entry
As an oligopoly is controlled by few large producers, certain barriers are in place
to intentionally or unintentionally deter potential competitors. Market reputation and
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name recognition of already existing firms are natural deterrents for entry of others.
Access to technology, and patents, as well, may exclude competitors from having the
capacity of join and participate in the industry. A more deliberate barrier from the
oligopolists would be in the form of pre-emptive and retaliatory pricing that would not
allow potential entrants to envision its growth in the industry.
Substitutes
Firms that produce substitute products, on the other hand, need not enter the
oligopolistic market yet benefit from it. These alternative goods, especially of cheaper
cost than the goods of oligopolistic firms, may constrain profit maximizing of the latter as
the demand of the substitute will increase when the price of the oligopolistic good
increases.
As an example, the existence of home-based movie entertainment in the form of
DVDs, both original and pirated, has distressed the theatre-based movie industry due to
the cheaper costs of the former.
Suppliers
Input markets of the oligopoly, or suppliers, play a role as well in determining
strategic decisions of firms. Higher inputs translate to higher production costs for
oligopolistic firms. As such, less flexibility on profit maximizing is incurred due to
competition of other firms in the oligopoly and also due to the existence of cheaper
substitutes. In this regard, it is essential for the oligopolists to have positive bargaining
dynamics with suppliers to obtain inputs at the least possible cost.
Buyers
Buyers or consumers are also an essential force that can greatly affect pricing
and production of oligopolistic firms. For firms whose outputs are purchased as inputs
by other major industries, the latter could assert powerful negotiating terms that can limit
the oligopolistic tendencies of the industries.
A good example of an influential buyer would be Mercury Drug to the
pharmaceutical companies. With Mercury Drug being the leading and sole nationwide
drug store, its ability to negotiate with pharmaceutical companies could affect pricing in
favor of the buyer.
OLIGOPOLY MODELS

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Evidently, there is no singular type of oligopoly. The interconnection of
oligopolistic firms results into multifaceted market conditions. However, one thing is for
sure that an oligopolistic firm will implement actions and strategies depending on the
behaviour of their competitors in the same industry.
THE COLLUSION MODEL
Ideally, firms function independently, exerting effort to maximize profits to achieve
their economic and financial gain. In an oligopoly, however, an opportunity for the firms
to join together and conspire to control the market, is available and upon reach. The
incentive here is greater, though in most cases, illegal. By colluding in the setting of
price of their products, and in the quantity of output production, firms will tend to obtain
a bigger share in the pie. This cooperation among rivals, where they will only produce to
a point where marginal revenue will equal marginal cost, will consequently drive prices
at above marginal cost, and earn them higher profits.
Cartels
One explicit collusive strategy being undertaken to manipulate pricing is through
cartels. These producers decide to agree to cut production and increase price. Cartel
agreements by colluding companies, especially those that produce inelastic products
and where substitutes are not readily available, therefore provide member-firms a
maximized profit while limiting costs.
The Organization of Oil Exporting Countries (OPEC) has been successful in
controlling and raising petroleum prices around the world. Having a product that is
essential to the day-to-day living of households and other industries, consumers are
strained to purchase though heavily burdened with an overpricing of the said goods.
Incentive to Cheat
While cartels bring about gains to be shared by its members, individualistic
desires to earn more give them an incentive to cheat. Selling products at the price lower
than the cartel-pegged will accordingly be more consumer-friendly and therefore be
preferred than the others. This kind of action will inevitably break the cartel and revert
back to a more competitive industry.
The existence of cartels, especially in the Philippine product arena, is difficult to
prove. Admission to being a member of such will land one in jail, not to mention the
negative effects on product reputatation. Philippine industries allegedly practicing
cartels include oil, cement, rice, insurance and construction contractor firms.

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THE PRICE LEADERSHIP MODEL
Price Leadership is a type of oligopoly model where the Dominant Firm, usually
the biggest or most efficient, initiates the changes in the pricing of a product, and all
other firms decide to follow its lead. This typically occurs in an industry where there is
one large firm and a number of smaller but relatively competitive firms.
This type of model has its similarities with the collusion model in the sense that
price is dictated and indirectly agreed upon by other oligopoly parties. It differs, though,
to collusion in the manner that there is no direct coordination or secret meetings
involved in determining price. The dominant firm could not be certain if the other firms
will go along with their price change.
This model would seem beneficial to smaller companies when the dominant firm
decides to raise prices. However, when said firm moves otherwise, or lowers prices,
then predatory pricing occurs. The drop in product price of the dominant firm may lead
the smaller firms to struggle in following suit and therefore close shop and leave the
dominant firm to monopolize the industry.
Loan Pricing of Universal Banks in the Philippines, such as Banco De Oro
(BDO), Metrobank and Bank of the Philippine Islands (BPI) are examples of firms
exhibiting price leadership in their industry. These three banks more often than not,
command the standard/prime rates being upheld in the banking sector, which other
banks follow.
Another example would be the Big Three petroleum companies which,
individually, announce their price adjustments through media, effective the next day.
Not long after, other petroleum firms will duplicate the adjustment and practically have
the same price as the leading firm.
Graphical Representation
Price-Leadership Model of a Dominant Firm

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THE KINKED DEMAND CURVE MODEL

The Kinked Demand Curve Model can be comparable to the Price Leadership
Model in terms of the pricing of one firm, which when lowered, are followed by other
firms. However, it differs from the latter when the other firms decide not follow, but
instead hold their ground, when such a firm increases its price. Pricing a certain product
above its demand curve will be elastic, and when there are relatively strong competitors
in the industry, then consumers will tend to prefer the one who sells it at cheaper cost.
The Philippine Airline Industry may very well resemble a kinked demand curve
model. With the entry of smaller but more specialized airliners, a decrease in ticket
pricing of the leading company, Philippine Airlines (PAL), may also drive down the same
from Cebu Pacific, Air Asia and the like. However, an increase in ticket pricing of PAL
does not necessarily translate to the other airliners adjusting theirs as well. By leaving
prices at a stagnant, consumers who can no longer afford PAL will transfer to the rivals.
THE COURNOT MODEL
The relationship of Interdependence among firms, particularly among two firms,
or duopoly, is illustrated by the Cournot Model. In this model, assuming that said firms
exist to maximize profits, and that each considers the output of the competitor as a
given, then these will be a firms basis to decide on its quantity of production. In the lens
of the market, a firms projection and expectation on the supply that its rival will produce
will be the foundation for computing for the available market left, thus choose the best
scenario of output to maximize profits.
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This model has a resemblance to the Nash Equilibrium where a firm of an

oligopolistic industry is performing its best given its competitors own actions.
Continuous practice of this reactionary model, especially as the number of firms
in an oligopoly increase, and as the cycle persists, would induce behaviour of firms to
produce fairly close product quantities such that output would be greater than monopoly,
but lower than perfect competition. Price also in the Cournot model would be lower than
monopoly, but still higher than perfect competition.
A relatively close example of the Cournot Model applied in the context of
Philippine firms is the interplay between Pepsi and Coke. In 2006, Pepsi released its
new product, Pepsi Max, as a pioneer of sugar-free carbonated beverage in the
Philippines. Coca-Cola, being the primary rival of Pepsi in the country, took a longer
time in following suit. It may be inferred that Coke used the time to project the level of
output Pepsi produced for their Pepsi Max. In 2008, Coke responded with their release
of Coke Zero, a product similar to Pepsi Max, in target-market and in price. However,
Coke employed a strategy of saturating the market with Coke Zero. By producing an
output greater than Pepsi, this presented Coke Zero with greater product visibility and
availability compared to Pepsi Max.
GAME THEORY
The behaviour of the pricing of oligopolistic firms is indeed complicated. Different
strategies, price or non-price, legal or illegal, have been done to maximize profits and
generate a bigger market share. One strategy being used to analyze the choices made
by rival firms, anticipating their action, while deciding on how to maximize its own profit
and well-being, is the Game Theory.
In this theory, oligopolistic firms are mutually interdependent with competitors in
pricing their products. Being interdependent, enticement to collusion is strong and will
enhance profits, yet self-interests can prevent conspiracy and allow firms to be more
creative in acting and reacting to competitors to gain higher profits.
In industries where collusion is not practiced, a type of Prisoners Dilemma takes
place in deciding whats best for one organization, given the actions of the players.
The Prisoners Dilemma
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Various strategies are employed in the decision-making of a firm in relation to the

anticipated action of the competitors. One would be the dominant strategy where a firm
chooses the best strategy regardless of what its rival decides on doing.
Another would be the maximin strategy where a company chooses to maximize
the minimum gain that it can achieve. Employing this strategy presupposes that the
competition will be executing a strategy that will do the most damage.
Tit-for-Tat, in contrast, is an approach where a firms response to an action of its
rival shall be of benefit to the latter.
NON-PRICE COMPETITION
Though pricing and product development are regarded as a basis for maximizing
ones profits, competition in an oligopolistic industry also come in the form of the
differentiation of the firms of their products through non-price means. Their delivery of
goods, product quality, location or proximity to consumers, and offerings of special
services, attempt to add value to the product without touching on the price. Non-price
competition prevents price wars, and award consumers their moneys worth without
having to shell out extra charges.
In the Philippines, usual non-price strategies come in the form of discount /
loyalty cards (such as the SM Advantage Cards), heavy advertising (Sin products,
beverage Industry), extension of shopping hours (supermarkets, drug stores) phone
shopping (supermarkets, National Bookstore), and free / fixed delivery services
(McDonalds).
CONCLUSION THE ROLE OF THE GOVERNMENT
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The Philippines has a wide range of laws and statutes that deal with the various
aspects of competition such as monopolies and combinations in restraint of trade,
restrictive business practices, price control measures and consumer protection. In fact,
the concept of anti-trust regulation or competition policy is not new to the Philippines.
Old anti-trust provisions of US laws (e.g., Sherman and Clayton Acts) found their way
into the Philippines Constitution, the Revised Penal Code and the Civil Code.
The Philippine Constitution, the highest law in the land, prohibits and regulates
monopolies, combinations in restraint of trade and other unfair trade practices. Under
the Constitution, there should be free competition, frowning upon monopolies and
combinations thereof, based on Article XII, Section 19.
The phrase no combinations in restraint of trade or unfair competition
essentially refers to an oligopoly as explained by the Supreme Court in the case of
Garcia versus Executive Secretary [G.R. No. 132451. December 17, 1999]. Specifically,
the Supreme Court stated that
"(w)here two or three or a few companies act in concert to control market prices
and resultant profits, the monopoly is called an oligopoly or cartel. It is a
combination in restraint of trade.
The current Philippine government recognizes the importance of having an antitrust law similar to that in the US in the past years, however unfortunately, the previous
administrations does not seem to prioritize this. In his first SONA in July, President
Aquino had urged the Congress to pass a new anti-trust law putting it as a main
concern of the government. As basis for this law is the anti-trust law in the US which
gives the US Federal Trade Commission and the US Department of Justice broad
powers to protect consumers and abate anti-competitive practices in commerce.
Present laws for promoting competition in the Philippines have been proven
inadequate or ineffective to prevent the ill effects of anti-competitive structures and
behavior in the market, mainly due to lack of enforcement and teeth. Despite the
considerable number of laws and their wide-ranging nature, competition has not been
fully established in all sectors of the economy, nor has existing competition in other
sectors of the market been enhanced. These laws have been hardly used or
implemented as may be seen by the lack of cases litigated in court. The same laws
have even discouraged competition.

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Some argue that the regulation is no longer a proper role for government.
However, as evidently seen, cooperation among oligopolists is undesirable from the
standpoint of society as a whole, because it leads to production that is low and prices
that are too high. To move the allocation of resources closer to the social optimum,
policymakers should try to encourage firms in an oligopoly to compete rather than
cooperate. Thus, minimal regulation by the government is necessary to ensure efficient
allocation of resources and encourage competition in an oligopolistic market structure
and address barriers to entry.

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