Oligopoly
The strategic approach extends the single-firm point of view by recognizing that a firm’s profit depends not only on the firm’s own actions but also on the actions of competitors. Thus, to determine its own optimal action, the firm must correctly anticipate the actions and reactions of its rivals. Roughly speaking, a manager must look at the competitive situation not only from his or her own point of view but also from rivals’ perspectives. The manager should put himself or herself in the competitor’s place to analyze what that person’s optimal decision might be. This approach is central to game theory and is often called interactive or strategic thinking. The outline of this chapter is as follows. In the first section, we describe how to analyze different types of oligopolies, beginning with Michael Porter’s Five-Forces model. Next, we introduce the concept of market concentration, as well as the link between concentration and industry prices. In the following section, we consider two kinds of quantity competition: when a market leader faces a number of smaller competitors and when competition is between equally positioned rivals. In the third section, we examine price competition, ranging from a model of stable prices based on kinked demand to a description of price wars. Finally, in the fourth section, we explore two other important dimensions of competition within oligopolies: the effects of advertising and of strategic precommitments.
OLIGOPOLY An oligopoly is a market dominated by a small number of firms, whose actions directly affect one another’s profits. In this sense, the fates of oligopoly firms are interdependent. To begin, it is useful to size up an oligopolistic industry along a number of important economic dimensions.
Five-Forces Framework For 25 years, Michael Porter’s Five-Forces model has provided a powerful synthesis for describing the structures of different industries and guiding competitive strategy.1 Figure 9.1 provides a summary of the Five-Forces framework. The core of Porter’s analysis centers on internal industry rivalry: the set of major firms competing in the market and how they compete. Naturally, the number of close rivals, their relative size, position, and power, are crucial. (The following section looks closely at the notion of industry concentration to measure the number and sizes of firms.) Entry into the market is the second most important factor in sizing up the industry. We have already seen that free 1
The Five-Forces model is examined at length in M. E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Simon & Schuster, 1998).
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